The Art and Science of Assessing Asset Managers

chart and magnifying glass

Integral to any investment program is the process of evaluating asset managers who make the investment decisions. Since there are both quantitative and qualitative aspects to asset managers’ performance, this evaluation is both an “art and a science.” A holistic approach is necessary to determine how well an asset manager performs for its clients. Wespath applies thoughtful analysis when evaluating its asset managers.

For quantitative performance, the return on investments should not be evaluated in isolation. Other factors to be considered include a multi-cycle time horizon and a proper benchmark comparison. For qualitative factors, there should be alignment of interest between the asset managers and the asset owners. Asset owners also should note how well asset managers adhere to investment guidelines. While these factors do not form an exhaustive list, they are some of the most important factors that should be considered.

Evaluate Performance for Consistency over Time

Assets owners should review investment results over multiple economic cycles. All investors in a market move through the same peaks and troughs that form the economic cycle. Asset managers need to steer their portfolios through these cycles. How well a manager steers becomes clear when witnessed over multiple economic climates. Not every investment decision undertaken by a manager leads to a superior outcome, nor does every portfolio positioning return favorable performance in every time period. Only through a consistent and repeatable investment process can asset managers guide their portfolios to long term outperformance over their benchmarks.

Ensure Benchmark Comparisons are Appropriate

It is easy to hastily (and, therefore, improperly) judge the returns of an investment portfolio merely by comparing it to its benchmark. However, some benchmarks may not be appropriate. Sometimes benchmarks are selected based on what is widely accepted by the industry; in other instances, benchmarks may lose relevance over time due to changes in the underlying investment portfolio structure. Selection of a proper benchmark is a key step when hiring an asset manager. More information on benchmarks can be found in our recently published Wespath white paper “Did Your Asset Manager Choose an Appropriate Benchmark?”

Determine Whether Interests Are Aligned

In terms of the qualitative aspects of an asset manager’s evaluation, alignment of interest is a critical factor—it is a key tenet of the asset manager/asset owner relationship. This factor can be illustrated by using Environmental and Social Governance (ESG) issues as an example. Wespath Benefits and Investments (Wespath) takes pride in being a leading proponent of socially responsible investing and includes ESG factors in its investment process. Wespath incorporates ESG related questions in both existing manager due diligence and new manager searches. When assessing asset managers, Wespath takes into account how well the asset managers incorporated ESG factors in their investment decision making. ESG is just one example that shows how important it is for there to be an alignment of interest between asset managers and asset owners.

Assess Adherence to Investment Guidelines

Investment guidelines provide the investment objective and detail any restrictions that an asset manager must adhere to in the portfolio. They should be established at the inception of every investment management relationship. Over time, the characteristics of the investments within an account may shift due to changes in the market. It is even possible for these characteristics to stray beyond the allowed ranges laid out in the investment guidelines. It is the asset manager’s responsibility to comply with investment guidelines. When assessing an asset manager’s overall performance, an asset owner must examine how well a manager adheres to investment guidelines. Many asset managers utilize highly sophisticated systems to ensure compliance to investment guidelines. Wespath also uses an automated system to monitor asset manager guideline compliance.

These are a few of the many factors that must be considered when assessing an asset manager. In the end, asset managers are fiduciaries with the ultimate objective of acting in the best interest of their constituents. Therefore, a true assessment of an asset manager’s performance must end with the question: “Has the manager performed in the best interest of the customer?” Answering that question is both an art and a science.

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