Investment Manager Analysis E-Book

Frank J. Travers

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 532

Veröffentlichungsjahr: 2011

Beschreibung

Praise for Investment Manager Analysis "This is a book that should have been written years ago. It provides a practical, thorough, and completely objective method to analyze and select an investment manager. It takes the mystery (and the consultants) out of the equation. Without question, this book belongs on every Plan Sponsor's desk." --Dave Davenport, Assistant Treasurer, Lord Corporation, author of The Equity Manager Search "An insightful compendium of the issues that challenge those responsible for hiring and firing investment managers. Frank Travers does a good job of taking complicated analytical tools and methodologies and explaining them in a simple, yet practical manner. Anyone responsible for conducting investment manager due diligence should have a copy on their bookshelf." --Leon G. Cooperman, Chairman and CEO, Omega Advisors, Inc. "Investment Manager Analysis provides a good overview of the important areas that purchasers of institutional investment management services need to consider. It is a good instructional guide, from which search policies and procedures can be developed, as well as a handy reference guide." --David Spaulding, President, The Spaulding Group, Inc. "This book is the definitive work on the investment manager selection process. It is comprehensive in scope and well organized for both the layman and the professional. It should be required reading for any organization or individual seeking talent to manage their assets." --Scott Johnston, Chairman and Chief Investment Officer, Sterling Johnston Capital Management, LP "Investment Manager Analysis is a much-needed, comprehensive review of the manager selection process. While the industry is riddled with information about selecting individual stocks, comparatively little has been written on the important subject of manager selection for fund sponsors. This is a particularly useful guide for the less experienced practitioner and offers considerable value to the veteran decisionmaker as well." --Dennis J. Trittin, CFA, Portfolio Manager, Russell Investment Group

Leseprobe

Contents

Introduction

Part One: Before the Analysis

Chapter 1: Setting Investment Guidelines

Investment Policy Statement

Conclusion

Chapter 2: Investment Manager Sourcing

Industry Changes

Nonlinear Process

Third Party Databases

Sample Screening Criteria and Techniques

Internal Databases

Media/Internet

Investment Consultants

Industry Contacts

Modifying the Search

Conclusion

Chapter 3: Request for Information

Formal Questionnaire

Simple Questionnaire

Sample Request for Information

Conclusion

Part Two: Equity and Fixed Income Manager Analysis

Chapter 4: Performance Analysis

Introduction

Conceptual Aspects of Performance Measurement

Practical Application of Performance Formulas

Aimr’s Performance Presentation Standards (PPS)

Composite Analysis

Chapter 5: Risk Analysis

Defining Risk

Measures of Risk

Chapter 6: Portfolio Analysis

Summary-Level Data

Fundamental Analysis

Chapter 7: Information Gathering

Questionnaire

Due Diligence Questionnaire

Section Two: Firmwide Professional Staff

Section Three: Operations

Section Four: Product Information (Equity)

Form ADV

Data from the Manager

News Search

Chapter 8: Initial Interview

Initial Meeting

Meeting Memo

Chapter 9: Attribution Analysis

Absolute Attribution Analysis

Relative Attribution Analysis

Interpretation of Relative Attribution Results

Historical Attribution Analysis

Currency Effect

Chapter 10: Style Analysis

Returns-Based Style Analysis

Style Analysis Explained

Evaluation of the Style Analysis Results

Style Graph

Rolling Style Analysis Graph

Attribution Analysis Using Style Analysis Results

Chapter 11: On-Site Meeting

Interviews with Investment Professionals

Interviews with Accounting and Operations Personnel

Interviews with Technical/Systems Personnel

Interviews with Legal/Compliance Personnel

Assessing the Office

On-Site Meeting Memo

Chapter 12: Investment Manager Scoring Model

The Model

Scoring Methodology

Investment Professionals

Process

Portfolio Risk

Performance-Related Risk/Reward

Organization

Operations

Manual Adjustment

Model Interpretation

Chapter 13: Background Checks and Contracts

Reference Checks

Background Checks

Credit Checks

Investment Contracts

Investment Manager Policy and Guidelines from the U.S. Equity Market Leaders Fund to Cam Asset Management

Chapter 14: Fixed Income Manager Analysis

Before the Analysis

Equity Manager Analysis

Fixed Income Manager Analysis

Performance Analysis

Risk Analysis

Portfolio Analysis

Information Gathering

Fixed Income Questionnaire

Section Four: Product Information (Fixed Income)

Interviewing Process

Attribution/Style Analysis

Investment Manager Scoring Model

References and Background Checks

Part Three: Alternative Investment Manager Analysis

Chapter 15: Hedge Fund Manager Analysis

Hedge Fund History

Hedge Fund Strategy Evolution

Hedge Fund Strategies

Hedge Fund Due Diligence

Hedge Fund Manager Interview

Hedge Fund Questionnaire

Section Four: Product Information

Hedge Fund Scoring Model

Alterations to the Model

Index

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Copyright © 2004 by Frank J. Travers. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Travers, Frank J.

Investment manager analysis : a comprehensive guide to portfolio selection, monitoring, and optimization / Frank J. Travers.

p. cm.—(Wiley finance series)

Includes bibliographic references.

ISBN 0-471-47886-5 (cloth)

1. Investment analysis. 2. Portfolio management. I. Title. II. Series.

HG4529.T735 2004

332.6—dc22

2004005532

To . . .

. . . my wife and best friend, Tara, who has offered me encouragement and support not just during the months it took to write this book, but over the course of our lives together.

. . . my children, Brendan, Sean, and Lauren, each of whom inspires me to be a better man than I thought I could ever be.

. . . my parents, who instilled in me a strong work ethic and who always told me that I could do anything that I put my mind to.

Introduction

According to statistics collected by Standard & Poor’s and presented in its annual Money Management Directory, there were just over 13,000 investment advisers managing money in the United States at the end of 2002. Nearly a quarter of those firms managed more than $100 million in assets. Some are of these investment companies are large, well-known firms with dozens and sometimes hundreds or even thousands of employees and with client bases spread out across the globe; others are small one-or two-person shops that service a more localized clientele. The products they manage range from publicly traded mutual funds to commingled trusts to separate accounts designed for individual clients. In addition, the product mix is quite diverse, covering a myriad of asset classes that differ across capitalization ranges, geographical boundaries, risk levels, and a variety of other classifications.

The assets managed by these firms at the end of 2002 totaled an astounding $21.3 trillion, representing more than 75,000 public and private pension plans—and these statistics do not cover the mutual fund industry.

Given those rather impressive statistics, you would assume that a wide variety of books and scholarly research papers covering the subject of investment manager analysis would be available to plan sponsors, investment consultants, financial advisers, fund-of-funds managers, and individual investors. While some books currently available are dedicated to or include chapters on topics such as performance analysis, attribution analysis, and portfolio analysis, to my knowledge no book has combined all the elements needed to effectively analyze investment firms, products, and professionals. Since a large percentage of the investments made in the United States on a daily basis are made by professional investment managers on behalf of their clients, I thought a book detailing a methodical process by which people could evaluate investment managers and the products they manager was long overdue.

INDUSTRY CHANGES

Over the past 15 years, I have found that the investment industry has changed considerably. Information that was available only to professional investors in the late 1980s (at very high prices) is now available free to all via dozens if not hundreds of web sites on the Internet.

When I first entered this field in the late 1980s, the primary issue was how to go about finding the best investment managers for specific searches. The Internet existed back then, but was scarcely used outside of academia and the military. In addition, the process of conducting a search for an investment manager based on investment style, geography, or market capitalization was much more manual and time-consuming than it is today. Lastly, there were no real reporting standards in place back then, so I spent a great deal of time poring over reams of printed material and then entering the data into spreadsheet programs that I had designed to dissect the data and put it back together—all this in an effort to make data from different firms comparable.

The issue today is quite different. It is no longer how to get the information; it is what to do with all the information now available. Technology has obviously changed this business in many ways. For example, it has made it possible to conduct complicated statistical studies in a matter of seconds. Studies that would have taken days (or possibly weeks) just a few decades ago can now be accomplished with the push of a few buttons. In addition, advances in computer hardware have given rise to the investment software industry. As computers got smaller and less expensive and as processor speeds increased, the types and sophistication levels of analytical techniques increased right along with those advances.

There are software packages that will perform manager screens for you or analyze style, performance, or portfolio fundamentals at the touch of a button. In addition, the advent of the Internet as a source of information and communication has been nothing short of monumental. I could not function as efficiently without the Internet and e-mail capabilities.

However, these advances, while generally positive, can lead to an overload of information—in effect prompting many not to see the forest for the trees. In addition, as we come to rely more and more on computer programs to perform complex analytical functions, we tend to forget some of the theory and investment mathematics behind the analytical reports. However, having access to various analytical reports is one thing; the ability to understand and interpret the reports is another thing entirely.

Yet for all the changes that have occurred in this industry over the years, much has stayed the same. While it is true that we now have access to much more information than we did a decade ago, the most important element of the process has remained exactly the same: Investment products are invariably managed by investment professionals (even quantitative strategies need to be created, monitored, and tweaked by people). Understand the people, and you are more than halfway there. The analytical process described in this book combines both qualitative and quantitative measures, which effectively combine the art and science of evaluating and selecting investment products.

THE SEARCH PROCESS

To give a complete picture of the steps that go into a typical search for an investment manager, this book outlines the process from start to finish.

Step One: Set guidelines.

Investment policy statement.Submanager guidelines.Setting responsibilities.Budget issues.Operational issues: time frame, asset size, etc.

Step Two: Source investment managers.

Internal/external databases.Media: newspapers, magazines, journals.Internet.Professional contacts.

Step Three: Screen the universe.

Setting minimum standards.Risk/return parameters.Fundamental characteristics.Style orientation.

Step Four: Request and organize information.

Performance.Portfolio holdings.Professional biographies.Form ADV.Presentation books and firm literature.

Step Five: Analyze managers and products.

Initial phone interview.Performance analysis.Style analysis. Risk analysis.Portfolio analysis.Factor analysis.Face-to-face meeting.Ranking model.

Step Six: Compare finalists.

Investment professionals.Process used.Portfolio characteristics.Performance.Portfolio turnover.Fees.Asset allocation.

Step Seven: Select manager(s).

Optimization relative to existing managers.Investment committee.

Step Eight: Prepare contract.

Investment manager guidelines.Fees and calculations.

Step Nine: Monitor manager(s) hired.

Monitoring manager(s) using all tools listed in step five.Transaction analysis.Continuously optimizing each manager versus rest of overall portfolio.

The book was structured to follow this general outline. Also bear in mind that the search process is actually more circular than linear—the analytical stage leads to the hiring stage, and once a manager is hired we start back at the analytical stage in order to monitor the manager’s effectiveness. The steps previously listed do not have to be followed in strict order. When analyzing an investment manager, the steps can be altered and changed as a result of scheduling, information delays, and a variety of other factors.

OUTLINE AND STRUCTURE

The structure of this book is designed to take the reader through all the stages of the investment manager analysis process. Each chapter focuses on a different aspect of the process or on a different asset class. To better illustrate each of the formulas and concepts detailed throughout the book, I created a fictitious investment firm, CAM Asset Management, and use the data from CAM’s underlying portfolio to illustrate how to perform each calculation and, more importantly, how to evaluate the results. Each formula and analytical technique discussed in the book is broken down and explained in great detail. CAM Asset Management is a fictitious investment firm that is based on a composite of investment firms that I have analyzed over the years. The investment team at CAM is also fictitious.

My ultimate goal in writing this book is to provide a practical, real-life method of analyzing investment managers—not to create a purely academic treatise. As a result, the style and tone that I employed when writing this book straddle the fence between academic and conversational.

Each chapter begins by defining all the relevant issues, concepts, and formulas. As the chapter progresses, each formula, concept, and analytical technique is identified and explained in detail. The organization of the book is also by design. The book’s first part deals with all the preliminary (background) work that needs to be done before we can actually begin to analyze an investment manager. The second part focuses on traditional asset classes, such as equity and fixed-income investment managers. The final part focuses on an alternative investment product: hedge funds.

Part One

This part discusses the steps that typically precede the actual manager analysis. Chapter 1 focuses on the identification of investment guidelines and investment manager objectives. Chapters 2 and 3 outline the methods currently available to source investment managers and discuss how to quickly and efficiently obtain enough relevant information to cull the list of prospective managers down to a smaller, more manageable list.

While not the focus of this book, I consider these chapters to be the foundation with which any successful investment manager analysis could be conducted. Setting objectives is a critical element in the overall process because it provides a frame of reference by which we will be able to make efficient and effective decisions. It also allows investment manager analysts to effectively and efficiently manage their time. Naturally, once we set the objectives, we then need to find an appropriate universe of investment managers as well as a means of fine-tuning the list. Finally, it is important to develop an efficient means of collecting data for evaluation. This data needs to be easily obtained and consistent for all the investment managers under review.

Part Two

Now that we have formed our objectives and written the specific investment manager guidelines, the real fun begins. This part focuses exclusively on the process of analyzing equity and fixed income managers. Because the process in which we evaluate equity and fixed income managers is similar, rather than repeating the entire process, I chose to focus on equity in our case study (CAM Asset Management) in Chapters 4 through 13. At the end of the part a separate chapter (Chapter 14) discusses fixed income manager analysis. I elected to highlight equity manager analysis because it represents the majority of assets held by pension plans, foundations, and endowments as well as by individual investors. The equity manager analysis section sets the tone for the rest of the book.

Each chapter in Part Two provides further information about the investment manager across a variety of due diligence topics. I have structured the chapters to follow the order that I typically use when conducting investment manager analysis, but the order is not as important as completing each of the analytical stages before making any decisions.

Part Two takes you through each stage of the analytical process and provides specific formulas and their real-world applications where appropriate. This part focuses primarily on domestic (U.S.) analysis, but to address the growing global nature of this business, I have included examples of international (non-U.S.) equity portfolios when appropriate to highlight differences in the analytical approach used or to address issues raised when reviewing non-U.S. portfolios and/or investment companies.

As you read through the chapters in Part Two, you will see how the evaluation process unfolds. Conclusions based on data in Chapter 5 may be refuted based on newer information we find later on in the process or by the results of additional analytical tools employed. Because many of the conclusions stated in the book are interpretive, you will likely find yourself agreeing with my conclusions some of the time and disagreeing with them at other times. This is normal, healthy, and to be expected.

Investment manager analysis is not a pure science. As a result, we all bring our own unique experiences, prejudices, biases, and opinions to the table. This book will explain how to analyze a given investment manager; it will not tell you which one you should hire—that decision needs to be based on your own specific needs and objectives.

Part Three

This part highlights alternative investment managers—specifically, hedge funds. Hedge funds are receiving more and more attention from institutional investors with each passing year. As a result, a plethora of new hedge funds has flooded the marketplace.

While many of the analytical techniques that we use to evaluate equity and fixed income managers can also be used to evaluate alternative managers, this part will highlight the unique analytical problems that arise in these asset classes. For example, information transparency is a realistic issue when attempting to analyze hedge fund managers.

While not exhaustive, Part Three will highlight the issues and offer an outline to be used when evaluating investment managers in this area.

AUTHOR’S NOTE

I have worked very hard to bring you this book and have spent a great many hours sitting at my laptop working through the first and many subsequent drafts. I have found the process of writing this book to be both rewarding and frustrating. I have tried to make this book comprehensive, practical, and relevant to people experienced in this field as well as to newcomers—not an easy task, I can assure you.

I hope that you find this book helpful, and I would encourage you to contact me if you have any questions or suggestions related to the book or any topic related to investment manager analysis. My e-mail address is [email protected]. In addition, I would encourage readers to visit my due diligence web site.

Web Site: Due Diligence Network

I created this site to provide cutting-edge research and to discuss advancements in the field of investment manager analysis. It is a not-for-profit site and is supported by numerous academics and industry professionals. It contains a variety of papers, articles, and other materials relating to investment manager analysis across all asset classes, including:

Performance analysisRisk analysisAttribution analysisStyle analysisPortfolio analysisInterview techniquesWeb site name:Due Diligence NetworkURL:www.neckerscube.comE-mail:[email protected]

PART ONE

Before the Analysis

CHAPTER 1

Setting Investment Guidelines

Before jumping headfirst into a pool, first check to see that it is filled with water.

It might sound a bit simplistic, but before we attempt to find and analyze any investment managers, we should first have a very clear idea of what we are trying to achieve by hiring the manager. This way we will be able to put each investment product in its proper perspective. A value manager can be reviewed in the context of the value style and can be properly compared to a universe of other value managers. Likewise, a short-term domestic fixed-income portfolio can be compared to the appropriate benchmark and peer group. This practice will save time and make the process much more efficient.

Investment guidelines come in two primary stages: (1) the investment policy statement (IPS) and (2) the investment portfolio guidelines. The former concerns the overall portfolio or fund (such as a pension plan), while the latter is targeted toward each manager hired to fulfill specific objectives within the overall portfolio/fund (see Chapter 13). As common sense dictates, all investment guidelines should be well thought out and should cover every aspect of the investment process, from risk/return expectations to manager selection to portfolio monitoring. In addition, manager guidelines should leave nothing open to interpretation. Fiduciaries charged with hiring investment managers as well as the investment managers themselves should understand the guidelines and willingly agree to them. This avoids potential headaches down the road.

INVESTMENT POLICY STATEMENT

An investment policy statement sets the framework for all of the investment decisions that follow. When well written, the IPS helps to ensure that the decision-making process with respect to the management of the total portfolio will be consistent and will serve as a beacon to aid navigation through unexpected market fluctuations and sometimes tumultuous economic conditions, enabling all parties to concentrate on what they were hired to do (or what they do best). A well-written investment policy statement typically addresses, but is not limited to, the following issues:

Philosophy or purpose.Return/risk objectives, including thresholds.Time horizon.Type of plan or portfolio.Status of plan funding.Actuarial assumptions, including clearly stated reasoning behind the return/risk objectives.Cash flow needs or liquidity.Strategy being employed to meet the investment objectives.Permissible investments (financial instruments and asset classes). Restricted investments (instruments and asset classes).Asset allocation ranges.Benchmark(s) for total portfolio.Benchmarks for each individual component of the total portfolio (asset classes, individual managers, styles, etc.).Plan/portfolio responsibilities (board, investment committee, consultants, etc.).Policies regarding external hires, such as consultants and investment managers (including language on fees, use of competitive bidding process, due diligence process, hiring/firing policies, placement of external hires on the watch list).Portfolio and performance evaluations (standards and procedures).Benchmarks and rebalancing policies.Diversification (by manager, portfolio size, geography, investment characteristics, asset classes, etc.).Portfolio execution and trading strategy.Operational issues (custodial, administrative, spending policy).

However, the investment policy statement should not be written in a vacuum. Economic and market conditions evolve. As they do, it is imperative that the investment policy statement be reviewed at least yearly on a strategic level and perhaps more often on a tactical level so that the portfolio has a chance to evolve along with the market.

Many pension plans currently conducting searches for alternative investment managers, such as hedge funds, only recently changed their investment policy statements to allow investments in this segment of the market. These adjustments reflect the ever-changing nature of the investment industry. Just keep in mind that all change is not necessarily good. What might be a beneficial change for some might be detrimental to others.

Because the focus of this book is investment manager analysis (not overall investment policy), this chapter should serve as a general guide or outline for the development of a new or the evaluation of an existing investment policy statement. The remainder of this chapter will highlight each of the significant sections that good investment policy statements typically contain.

Investment Objectives

This section is a critical element in the IPS document because it sets the tone for everything that follows. It is here where the portfolio’s return and risk expectations are listed. Whenever the investment policy statement is reviewed, the ultimate goal is to ensure that the return and risk objectives have been achieved. As you can imagine, the objectives should be realistic and based on long-term assumptions. Many corporate pension plans got caught up in the bull market of the late 1990s and increased their pension plans’ return expectations far beyond what they could reasonably expect to achieve. This resulted in faulty pension assumptions that have had a detrimental impact on many companies’ financial statements and, in the case of some publicly traded companies, the prices of their underlying stocks.

For pension plans, return and risk objectives may be stated in absolute terms (example: the portfolio should return a minimum of 8% annually with a standard deviation no greater than 10% annually) or relative terms (example: the portfolio should have an annual return in excess of 200 basis points above the S&P 500 index with a standard deviation no greater than the S&P 500 index). A basis point represents 1/100th of a percent.

Funds of funds may also state their return and risk objectives in absolute or relative terms. However, because funds of funds are, in effect, individual investment products themselves, they tend to have a much more narrow investment focus (example: small-cap, large-cap, etc.). A fund of funds’ investment policy statement is typically called a “prospectus” or “offering memorandum.” Because there are legal requirements, investment policy statements and prospectuses tend to have different formats, but still contain all of the points listed earlier in this chapter.

Example of Investment Objective

The financial objectives of the plan are based on a comprehensive evaluation of the capital markets in the context of modern portfolio theory and have been measured against the plan’s current and projected financial needs. Based on this evaluation, the plan will be measured against a customized benchmark consisting of the following indexes in the proportions listed:

50% S&P 500 index10% Russell 2000 index10% MSCI EAFE index30% Lehman Aggregate index

The investment objectives for the plan are:

To achieve a nominal rate of return for the total portfolio equal to or greater than the return of the customized benchmark.To achieve a real rate of return in excess of 550 basis points above inflation, measured by the consumer price index (CPI).To keep the total portfolio’s level of risk, defined as annualized standard deviation, equal to or less than that of the customized benchmark.

Responsibilities

Once the objectives have been decided upon, it is important to clearly state who will be responsible for making sure that all the goals are accomplished. This is an important section because it specifies who is responsible for every aspect of the portfolio’s management. This includes boards, trustees, internal employees, external investment managers, consultants, legal advisers, and others.

This section offers guidance not only to outsiders looking to establish contact, but also among co-workers who share portfolio analysis and management responsibilities. It is basically a detailed organizational chart that sets the pecking order within an organization.

Asset Allocation

Asset allocation is the subject of entire books, so I will simply state here that it comes in several levels. First, there is strategic asset allocation. This form of asset allocation is long-term in nature and is seldom changed or altered. Changes to asset allocation that occur due to short-term shifts in economic or market conditions are most often referred to as tactical asset allocation. For a pension plan, the strategic asset allocation decision is most often arrived at by conducting an asset/liability study, where the fund’s liability characteristics are considered when developing the fund’s asset allocation policy.

This typically leads to a list of what asset classes and financial instruments are permitted for purchase. In addition, the list typically states the minimum and maximum weights according to asset class, market capitalization, investment style, and so on. Exhibit 1.1 depicts sample asset allocation guidelines that are broad, while the asset allocation guidelines depicted in Exhibit 1.2 break the main asset classes down into a variety of subcategories. The more detailed the asset allocation, the more efficient the overall process will be. For example, it would be easier to perform attribution analysis when the asset classes have been defined in greater detail. Also, to create detailed asset allocation guidelines, you need to really think through the entire process and, ultimately, hold the investment committee or lead investment professionals responsible for the portfolio’s out performance or underperformance.

EXHIBIT 1.1 Sample of Broad Asset Allocation Guidelines

Asset AllocationAverage %Equity50Fixed income40Alternative asset classes5Cash and equivalents5

EXHIBIT 1.2 Sample of Detailed Asset Allocation Guidelines

In addition to breaking out the underlying asset classes further, the detailed asset allocation guidelines set minimum, maximum, and average weights for each asset class. When setting the guidelines it is critically important to set asset allocation guidelines that parallel the return/risk parameters set in the investment objectives section of the investment policy statement. For example, it would be nearly impossible to achieve a long-term return in excess of 8 percent if the asset allocation guidelines emphasized short-term fixed income securities and prohibited equity investments and other asset classes that appear on the higher end of standard return/risk profile charts. An example of a standard risk/return profile based on long-term historical performance for various asset classes is depicted in Exhibit 1.3.

EXHIBIT 1.3 Risk/Return Profiles by Asset Class

Short-term bonds appear in the low risk/low return quadrant. In order to achieve a long-term return of roughly 8%, it would be necessary to invest in some of the asset classes that appear higher up on the risk/return line. A well-thought-out and well-written IPS will contain risk and return objectives that match the asset allocation ranges set within the document.

Investment Restrictions

This list is a compilation of any financial instruments (e.g., options) or investment strategies (e.g., currency hedging) that are not allowed. Restrictions can cover entire asset classes, specific transactions, countries, or exchanges, or can be taken to the individual company or organization level. Other examples include restrictions based on social, political, or religious reasons. A Catholic foundation, for example, may wish to avoid investing in “sin” stocks (typically defined as companies that are involved in the manufacture, sale, or distribution of alcohol, tobacco, and firearms). Once a process done largely by hand, the ability to flag any restricted purchases can now be achieved relatively easily at the custodial level or through various software packages. These restrictions should carry over verbatim to the investment manager guidelines (see Chapter 13) as well.

Portfolio/Performance Evaluation

Assuming you have a portfolio or fund that is up and running, it is imperative that periodic evaluations take place. As mentioned previously, the investment policy statement should be evaluated at least yearly. Questions to answer include the following:

Has the portfolio achieved its goals?If not, where did we go wrong and, more importantly, how do we fix it?How have each of the underlying managers performed?Have all the underlying managers stayed within their stated investment guidelines?

These and many other questions should be asked and answered on a consistent basis. This section typically states what will be evaluated, how it will be evaluated, and who will evaluate it, and sets very specific time frames. For example, an investment policy statement or prospectus may state that the underlying investment managers will be informally reviewed quarterly and formally reviewed annually (naturally the terms informally and formally must be defined). Some of the issues that are typically addressed in this section include:

Timing, frequency, and format of evaluations.Format to place investment managers on warning.Absolute performance.Relative performance (benchmark and peer group).Fundamental characteristics.Attribution analysis.Style analysis.Risk analysis.Minimum portfolio standards.Fees.Reporting standards and issues.

Operational Issues

Any number of things can be placed in this section, such as legal, accounting, custodial, administrative, and other issues. In addition, this section can also contain language that addresses the issue of proxy voting. Some organizations place that decision entirely with the underlying investment managers, while others place specific restrictions on particular issues that may arise. For example, a pension plan may specify that all proxy votes are to be voted as the company management sees fit, with the exception of issues relating to movement of labor from the United States to countries overseas.

CONCLUSION

The investment policy statement is a critical element in the ongoing management of any pension plan or investment fund. The guidelines set the tone for all the underlying investment manager searches and play a key role in the actual due diligence performed on any investment managers under review. The more explicit the investment policy statement, the easier it will be to actually manage the underlying pension plan or investment fund. In addition, because the risk/return objectives should be clearly stated in the investment policy statement, it is easier to evaluate the success or failure of the underlying pension plan or investment fund. As we learn in Chapter 9 (“Attribution Analysis”), we can conduct relative attribution analysis only when we have something concrete (a single index or a combination of indexes) to which to compare allocations and performance.

As we work our way through the investment manager analysis process, we will create a detailed set of risk and return objectives for the sample manager we select for the case study and build the underlying analysis one step at a time. This chapter has laid out a brief outline for developing an effective investment policy statement; Chapter 2 introduces a means of finding a broad list of potential investment managers and then demonstrates how to cull the broad list down to a few highly attractive candidates.

CHAPTER 2

Investment Manager Sourcing

Sourcing investment managers is much easier today than it was just a decade and a half ago. In the late 1980s, when I started in this business, the main question was how to find investment managers and to figure out the most efficient way of obtaining information about them and the investment products they managed. The search process was very time-consuming because much of the work that needed to be done was done manually. It was not uncommon to fax and/or mail out requests for information (RFIs) and then wait until the managers filled in all the information and mailed back the completed forms. Then the real work began. Often we would have to manually enter the data into our own systems and check its accuracy. Only after this manual process had been completed for all (or most) of the managers in a particular search could the analytical process begin.