AgPa #62: 10 Questions to Ask Your Fund Manager

The 10 Most Important Questions to Ask in Selecting a Money Manager (1990)
Jack L. Treynor
Financial Analysts Journal 46(3), URL

Continuing with the challenge of asset manager selection, this week’s AGNOSTIC Paper again focuses on the important soft factors of money managers. Jack Treynor, the author of this week’s paper and one of the giants in finance research, presents a short and entertaining checklist “to ensure that the right questions are asked […]”.

Everything that follows is only my summary of the original paper. So unless indicated otherwise, all tables and charts belong to the authors of the paper and I am just quoting them. The authors deserve full credit for creating this material, so please always cite the original source.

Setup and Idea

After covering papers on manager selection over the last three weeks (AgPa #59, AgPa #60, AgPa #61), there is really not much more to say about the setup and idea. Selecting asset managers is challenging because 1) it is active investing which is generally difficult, 2) it requires to evaluate the investment process and skills of an unknown person, 3) it requires to evaluate the business operations of the asset management company, and 4) it requires to evaluate the character of the fund manager. The questions in this week’s paper clearly focus on the last two parts.

Data and Methodology

The paper is a short checklist of relevant questions to asset managers and there is no specific methodology or data to discuss at this point.

Important Results and Takeaways

Before going into the results, one important note. I present the 10 questions as they appear in the paper. They fully belong to the author/publisher and I am just quoting them here.

Does the money manager present his ideas smoothly and without hesitation?

A seemingly perfect presentation with an entertaining rehearsed story-line, and without pauses or Ehms could indicate that the money manager’s ideas are old and most likely already reflected in market prices. According to the author, “Trading on such ideas cannot help your portfolio’s performance, but can easily hurt it.”

Is the money manager clear and confident about his ideas?

This is actually a big one. The manager should be able to communicate her ideas clearly and articulate a comprehensible vision. At the same time, it is critically important to challenge existing ideas and replace them with new ones if the evidence suggests to do so.

Do his ideas have common-sense appeal?

This question addresses to issues. First, to make money from an idea in financial markets you need a sufficient amount of investors to move in the desired direction. If an idea doesn’t have common-sense appeal, this is less likely. Second, and this is true for almost anything in life, an idea that is too complicated to explain it with common-sense is most likely not good one.

Are you comfortable with the money manager’s answers?

This question again focuses on two important issues. First, a money manager should obviously answer your questions such that you are left with more understanding than before.1It sounds intuitive but it happens all too often that you have more questions than before asking the first one… Second, you don’t want to have a manager who goes for the easy answers. For most issues in financial markets, there is no clear right or wrong and a money manager should restlessly question what is going on.

Does the money manager exhibit detailed knowledge of a broad range of companies and industries?

In my opinion, the wording of this question is a little misleading. The author argues that you don’t want to have a money manager who spends her time learning facts and figures about companies by heart. Those things are easily available to all of us and therefore most likely incorporated into prices. Money managers and investors should rather spend their time on developing novel and uncommon insights that are beyond the easily accessible information we all know.

Does the money manager react decisively to new developments?

I think this one need no further description. You obviously want to have a manager who reacts decisive and quickly to new developments if it is appropriate to do so.

Does the money manager have a large asset base?

Virtually all empirical studies don’t find reliable correlations between past and future performance of money managers. A large asset base usually comes from good recent performance or from having ideas that attract the interest of many people. While impressive, investors should always remember that this doesn’t necessarily translate into good future performance. In fact, profitable investment processes usually come with limited capacity. All else equal, more assets are therefore even counter-productive for performance.

Does the money manager live baronially—with expensive clubs; houses and cars; and travel by the QE II, the Concorde, or the Orient Express?

For this one, the author applies a somewhat cynical logic. Managers who are convinced that they can earn high returns on capital should 1) invest in their own funds, and 2) save a lot of their own money to capitalize on their skill. If I am confident to make 20% a year, my consumption patterns will change because I rather compound that money at this attractive rate. Managers who “waste” money on luxuries therefore might not have enough conviction in their investment processes.

Are his offices impressive?

Money managers of course not only have to invest money on behalf of their clients, they also need to manage their own business. The impressive offices in the question are synonymous for fixed costs in general. The fixed costs must fit with the profile of the manager to ensure the right incentives. Managers who just started out and committ themselves on an expensive rent probably focus more on marketing to gather assets than on their investment processes. More assets and higher fees are nice for the manager but usually not for their investors.

Is the money manager impressively capitalized?

This question is somewhat related to the previous one. The author argues that asset managers need sufficient but not excessive capital to do their jobs. Money managers who engage with partners to build-up impressive amounts of capital are therefore probably also more focused on marketing than on performance.

Conclusions and Further Ideas

Everyone must of course decide for herself if those are really The 10 Most Important Questions to Ask in Selecting a Money Manager. Yet, I think Jack Treynor actually captures a lot of the important soft factors with this short checklist and it is definitely helpful. For a full manager selection for your own capital our on behalf of a client, these questions alone are obviously not sufficient. But I think it is a good place to start and I believe it makes sense to at least partly formalize the manager selection process in such a protocol.

In a touch of self-praise, the author concludes by disclosing that he is himself an asset manager that, how should it be otherwise, has “[…] modest capital and assets under management, few clients and simple offices […]”.2I don’t think he means that sentence too seriously…. I don’t know about his track record as a money manager, but given that Jack Treynor was one of the most influential figures in financial economics we let him go with that.

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1 It sounds intuitive but it happens all too often that you have more questions than before asking the first one…
2 I don’t think he means that sentence too seriously….