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knowledge bank

Apr 05 2017
Lawrence Lam

How to pick a good investment manager

Investors' mentality

“The most important quality for an investor is temperament, not intellect… You need a temperament that neither derives great pleasure from being with the crowd or against the crowd.” – Warren Buffett


We are cognisant of the irony regarding this chosen topic. However it is a question we are asked with regularity. It is an important question for those who do not have the time to dedicate to stock market monitoring and have chosen to trust their funds with a professional manager. So we hope that in providing our view on this topic, we raise the awareness of what really matters to clients and drive improvement in the industry.

The decision of picking a good investment manager is an important one. It’s a decision that should not be based solely on fund performance. Doing so would be akin to buying a car solely based on its top speed. But what about other factors such as comfort and longevity? What about fuel efficiency? Does the car have enough space for your needs?

No doubt performance is one of the fundamental parameters to be considered, but equally important are temperamental factors of the investment manager. Just like a quality thoroughbred, a fund manager with the right temperament has staying power and longevity in the industry. You know they will be a front runner over the long haul.

Integrity

A fund manager with integrity pays the word more than just lip service. They will behave fairly and equitably for its investors. This extends to principles about the broader ethics of the companies they invest in. They will be transparent and communicate in an understandable, jargon-free style. They value the trust placed in them and uphold the highest ethical and moral standards.

This requires more due diligence than just reading offer documents. Importantly, aim to speak directly to the investment managers. Large investment managers may be harder to reach directly and their values diluted in bigger teams, but speaking directly with boutique fund managers is a good way to gauge if you feel a strong sense of trust. Look beyond the investment proposal and look for genuine signs of honesty. This trait is inherent in one’s personality. You either have it or you don’t. It’s not something you can learn or buy with money.

Curiosity

Curiosity indicates that the investment manager wants to learn more. Curious investment managers delve deeper into investment opportunities and will ask more pointed questions. Curiosity also hints at a sense of humility – a recognition that business models are constantly evolving and no investment manager knows it all.

Be mindful of those that exude unequivocal confidence in all aspects of their investing abilities. The test here is overconfidence. If the investment manager is overconfident, decision blind spots are more likely to lead to unsatisfactory investment outcomes.  As Warren Buffett says,

“In the world of investing a few people after making some money tend to imagine they are invincible and great. This is the worst thing that could happen to any investor, because it surely means that the investor will end up taking unnecessary risks and end up losing everything – arrogance, ego and overconfidence are very lethal.”

A good investment manager should be ‘appropriately confident’ – confident that their investment principles will serve them well, yet curious about ways to grow knowledge about new businesses and learn from past mistakes.

A pleasant outcome of a curious investment manager is that investors benefit from their expanding sphere of knowledge. They’re happy to share their knowledge and educate investors on what they’ve learnt.

Knowledge

The attributes above are temperamental for good reason. Investing is predominantly a behavioural art and success correlates highly with one’s ability to manage emotions. Temperamental attributes are personality based and can’t be learnt – they form the fundamental building blocks of a good investment manager.

But to win a race, every great thoroughbred relies on a great jockey. This is where financial knowledge is relevant. Every great investor draws upon a strong foundation of knowledge and sharp intellect. They should be appropriately qualified in finance, but more importantly, have an in depth understanding of how business strategy relates to financial theory. Their knowledge should be broad – seemingly unrelated industries can have huge impacts on business growth. Narrow thinkers would have failed to recognise the impact cloud computing would have on the traditional taxi industry.

An investment manager’s knowledge should shine through in their investment updates. Their commentary should be based on independent analysis.

Conviction

None of the above is useful without the final ingredient – conviction. When the research is done and the conclusion drawn, good investment managers won’t be hugging the index. They will have the conviction to trust their own knowledge and avoid over-researching. If necessary, they’re prepared to go against market consensus.

Luckily, the job of picking a good investment manager is easier than picking the winner of a horse race. It’s picking the winning horse over thousands of races, not just one race – and good horses with the right temperament and jockey will outperform over the long run.