The majority of investors’ attention is often focused on the performance of the funds or managers in their portfolio. And rightfully so. The numbers that appear on statements month after month will determine to a large extent whether an institution can continue to pursue its mission over an extended period of time.
Small levels of underperformance, when compounded, become material in just a few years. Great time and effort should be committed to finding managers and partners who have proven the ability to consistently generate strong returns. But those monthly performance statements are not the only arbiters of success or failure in the investing sphere. The areas of risk, legal and compliance, operations and information technology, to name a few, can all drive meaningful, tangible effects on investment outcomes.
Here are a few ideas to think about that were raised by the expert panel at Commonfund Forum 2019, “Risk Management and Operations: The Back Office Comes to the Front.”
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Conflict. If there is one thing to focus on while looking at investment managers, it is conflict. Are there any areas where the interests of the manager and the investor are not aligned? Are there affiliated entities siphoning off fees? Are there multiple fund vehicles running in parallel? Which one do the fund’s principals invest in? What is the allocation policy between them? Get comfortable with any potential conflict as a first step in assessing a manager. |
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Fees. Look at audited financial statements, not sales presentations, to determine the true level of fees that an investment manager is charging you. Many investment firms will trumpet their low management fee while passing virtually every expense they have through their investment vehicles. A large difference between gross and net performance can be a red flag. |
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Back Office. Established managers aren’t necessarily good managers when it comes to the back office. We have seen plenty of successful investment managers rest on their laurels after achieving early success. The push to spend valuable resources on supporting a best-in-class back office can take a back seat when fundraising is robust. If investors don’t demand safeguards, independence and oversight, they won’t appear. Once a fund or vehicle becomes capacity constrained, the investor has lost much of the leverage to force improvement. |
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Cybersecurity. One of the biggest risks that investment managers face these days is cybersecurity. Firms that handle large sums of money are always going to be a target and the threat landscape is always evolving. Each manager’s commitment to cybersecurity (through quality of staff, allocation of resources, etc.) is different. Assessing that level of commitment is essential to protecting your investment. If you aren’t equipped to do so, find an expert to help you. |
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Ongoing diligence. Lastly, do not let the day you sign the docs be the last contact you have with a manager. This business is about relationships and the relationship between manager and investor is one that requires attention. Be aware of what is going on with the manager in areas other than just performance. Have there been personnel changes? Regulatory inquiries? Service-provider changes? The more informed you are as an investor the better equipped you will be to handle a new piece of information that comes your way or compare the new, shiny manager with the one you’ve been in regular contact with. |
