The due diligence process offers managers the opportunity to showcase all components of their operations, from front office decision-making to back office policies and procedures. The dynamic between portfolio manager and analysts is a component that investors prioritize to understand. Clearly there is no “one-size-fits-all” solution as each manager has its own distinct firm culture. Investors are looking for signs of a collegial relationship.
There Is No “I” In Team
Some firms have very knowledgeable analysts whose voices are not being heard. In some cases the analyst is ineffective at conveying his money-making ideas. In other cases the analyst is indeed quite proactive at internally marketing his best investment ideas, yet orders reflecting this conviction are not being executed. The firm is left with two distinct silos whereby the portfolio manager and the analysts are not working together as a team. During the course of an enhanced due diligence the investor quickly becomes aware of this sub-optimal reality. The end result is that investors avoid allocating capital to managers where such a situation exists.
Investors Like Teamwork
Investors want to see a constructive research process, along with a transparent internal marketing structure. This can be a “push” or “pull” marketing strategy, or perhaps a little of both. The investment recommendation process can be varied. What investors like to capture through team member interviews and related documentation is that the process is consistent with discipline. When it comes to investment process: the more tangible the transparency the better. In order to minimize key man risk, investors are searching for a repeatable process, one that depends little on one single person. Diversity in the decision making reduces the likelihood that investors will have to seek out another manager should a key man be hit by the proverbial bus. A half-hazard freestyle process may work but it will most likely involves greater key-man risk and will therefore likely be viewed as less attractive.
Compensation Structure Is Critical
Over the course of performing mandates for clients, I have come across some dysfunctional investment management teams. In some cases, analysts have pointed fingers behind portfolio managers’ backs for not executing their investment ideas. On the flip-side, I have come across a portfolio manager that referred to an analyst as a “door mat”. This kind of juvenile finger pointing can be somewhat tolerated if front office compensation, including bonus, are properly structured. The ideal analyst is bright, hard working, articulate, proactive and competitive. In order to minimize the possibility of discontent, analyst bonus evaluations should be overseen by the head of research and need to be structured with a significant component tied to the quality of investment recommendations. In contrast, portfolio managers should have a large component of their bonus tied to performance (both relative and absolute) along with their thesis and how well it was executed.
The tug of war between analysts and portfolio managers will surely continue into the foreseeable future. For it is dictated by the human condition and its need for recognition in this particularly competitive landscape. Participants fear being viewed as irrelevant because such a label puts their livelihood at risk. Analysts want their investment ideas listened to and executed in a timely manner. Portfolio managers want analysts to feed them with great investment ideas. In other words, both groups have the same goal in mind and yet finger-pointing remains pervasive. For the investor, studying this dynamic during the due diligence process is imperative. It provides qualitative clues that the quantitative performance numbers alone simply do not.PDF version