Art & Science Archive
“The fundamental things apply as time goes by.”
— Sam the pianist in Casablanca
The CIO of one of our client companies recently asked the following question: “Do we have to include an investment philosophy exhibit in our book?” “Yes,” I told her, “you do. It’s required by the decision-makers in your market.” She responded, “But why? Why can’t we just cut to the chase of the investment process?” I did my best to provide a thoughtful answer at the time, deciding to explore the question later in writing. Here goes:
Institutional investors and their consultants have come to expect a thoughtful statement of investment philosophy. A strong philosophy statement sets the stage for a clear and interesting process description. It can even become the cornerstone of a distinctive identity. In volatile, emotional markets, a solid philosophy statement makes it easier to communicate with frightened or skeptical investors.
Why — Not What or How
Your investment philosophy should answer the question: Why do you invest the way you do? It should be about beliefs, not actions or goals. In human terms, a philosophy statement should tell investors why you get out of bed every morning to go to work and why you believe you can generate returns worthy of your clients’ fees. It should explain why you believe that you can outperform over time.
Many philosophy statements do not answer these fundamental questions. They never address the why — only the what or the how. The following examples are based on an Internet search for the term “investment philosophy”:
From a small-cap, concentrated portfolio manager: “We seek to invest in undervalued companies that are experiencing improving fundamentals.”
From an international all-cap portfolio manager: “We take a long-term view and focus on good or improving businesses.”
So do many other talented investors. But why do these companies believe that they can generate superior investment returns consistently?
Here is another, ubiquitous philosophy statement that fails to communicate a competitive edge:
From an active equity manager: “We believe that the stock market values companies efficiently most of the time but not all of the time.”
Why even bother to say this? For active managers, this merely states the obvious. It does not explain why a firm believes it can generate consistent superior returns in competition with other firms that, by definition, believe exactly the same thing.
A Unifying Belief System
By contrast, here are a few examples of strong philosophy statements discovered online:
From a value equity manager: “When properly analyzed, uncertainty can create a compelling investment opportunity.”
One can imagine how the phrase “when properly analyzed” might bridge to a cogent discussion of the investment process and the characteristics that differentiate this firm’s approach to investment research.
From a fixed income manager with a focus on analyzing individual credits: “We believe that the bond market is efficient with respect to interest rate risk, but regularly misprices securities that are exposed to credit, prepayment and liquidity risks.”
From a global equity manager specializing in sustainable investing: “We believe that sustainable development will be a primary driver of industrial and economic change over the next 25 years … Shareholders will best be served by companies that maximize their financial return by strategically managing their performance in this new economic, social, environmental and ethical context.”
Questions to Ask About Your Philosophy Statement
To gauge whether your investment philosophy statement articulates a true and convincing philosophy, consider the following:
- Can you preface each part of your philosophy statement with, “We believe that …”
- Does it provide a clear rationale for consistent outperformance?
- Does it answer the question, “Why?”
- Does it bridge decisively to the investment process — i.e., a discussion of the how that flows clearly from the why?
- Is it a real investment philosophy — or a mishmash of philosophy, process, objectives and portfolio characteristics?
- Is it stated in terms that are simple and concise? In researching this article online, we found several philosophy statements that were excellent in many respects, but too long to have the desired impact.
- Is it so obvious that it might make potential investors wonder, “Well, who doesn’t believe this?” For example, “We believe in capital preservation.”
- What kind of philosophy statement is it? The examples here relate to philosophy statements for an investment strategy, as opposed to the philosophy for investing in a given asset class or the firm’s overall philosophy of how to make money for clients. A firm-wide philosophy statement can provide a compelling introduction to your company. And a statement defining the rationale for an asset class can be invaluable when an audience is on the fence about investing or when the asset class is not yet well understood. But neither can replace, and neither should be mixed with, the investment philosophy that serves as a foundation for the investment process.
By explaining why in an honest, thoughtful, distinctive manner, an investment manager provides a clear rationale for the investment process and a basis for conviction, even during the most difficult market environments. That, I later told our client, is why the philosophy statement is a requirement in institutional marketing.
As the song says, “The fundamental things apply as time goes by” — and a good answer to the question “Why?” is about as fundamental as it gets.