Monthly insights for investment marketing and sales professionals
November-December 2014
How do true active investment managers sell themselves in a market that has become deeply skeptical regarding claims of active management? This issue of Excess Returns offers advice to active managers seeking differentiation from the crowd of closet indexers.
With best wishes,
Liz Hecht
Founder, Principal and Director of Research
Alpha Partners is an investment marketing firm specializing in research and presentation strategy. Our goal is to create alpha (excess returns) by helping investment firms win, keep and diversify assets under management.
I vividly remember the stab of dismay I experienced the first time I heard the term "benchmark agnostic." I understood that this was a new way to describe active management, but I could not reconcile the concept of agnosticism (lacking in belief, sitting on the fence) to an activity that requires conviction for success. Since that time, "benchmark agnostic" has become a term of art in the investment industry. It is widely used and most people know what it means.
As a human being, I want badly to believe in active management, to believe that the hard work and analytical powers of my fellow humans can generate excess returns. Sustaining this belief these days, however, has become increasingly difficult. The concept of being "agnostic" — the label many active managers now proudly wear — somehow does not convey the requisite conviction. And the rising popularity of active share as a measure of active management has made it easier to uncover the widespread practice of closet indexing among public equity managers. A study of institutionally focused products by Hewitt Ennis Knupp found that demonstrated skill in active equity has steadily declined since the 1990s to the point where "less than 2% of active equity managers have demonstrated evidence of skill net of fees."1
Less than 2%. That is one mighty depressing number. So what if you are an active manager in today’s increasingly skeptical market? How can you convince prospective investors that your strategy is truly active? Here are some suggestions.
Strategies for Selling Active Management
Tell a differentiated story. If your marketing materials and presentations don’t say anything different, how can you convince investors that you are doing anything different? A lot of investment firms claim to manage portfolios that are different from the benchmark, but based on review of their marketing and client communications, it is impossible to determine what these differences might be.
If you’ve got a concentrated portfolio, flaunt it. I have worked with many portfolio managers over the years who initially did not appreciate the marketing power of a concentrated portfolio. Their marketing materials emphasized "in-depth fundamental research" or "excellence in execution" or "a culture of integrity" — all nice to have but difficult to prove and not necessarily differentiating. According to a 2014 Cambridge Associates study, managing concentrated portfolios or a small number of portfolio positions "implies more conviction in each investment … [helping to] focus a manager’s attention and reduce the potential for complacency with smaller positions."2 And yet many concentrated portfolio managers don’t even mention the number of holdings in their communications — or, if they do mention a concentrated strategy, do not explain and consistently reinforce its merits.
Preempt any misperception that your portfolio may be overly diversified. The market’s appetite for concentrated strategies sometimes leads people to forget that portfolio diversification is still often necessary and desirable. In highly volatile, less efficient markets and asset classes, you may need to remind prospective clients that greater diversification does not equate with closet indexing but with more opportunities and less potential risk of capital loss.
Work harder to mitigate human behavior risk. In addition to closet indexing, one of the biggest enemies of active management is human behavior risk, manifested as the stated desire for active management combined with the inability to tolerate the volatility that comes with it. Given human behavior risk, Hewitt Ennis Knupp has recommended that investors treat high-conviction public investment strategies "as if they were illiquid like private investments, and pledge to resist making portfolio changes mid-stream."
From a sales, marketing and client service perspective, I see investment firms spending a lot of time communicating about how they measure and manage investment risk. But they should spend more time communicating in ways that mitigate human behavior risk.
There are a lot of white papers, studies and seminars providing education on the merits and challenges of long-term investing — worthy activities and events all at one remove from the process of getting and keeping clients. But rarely do I see marketing materials with education embedded in the story — education about when a strategy is likely to underperform and why and the benefits of being a patient client. Even if a firm does cover this information in its sales materials, only infrequently is it reinforced clearly and consistently in client service meetings. I suspect this is because, in the heat of battle while selling directly, some firms are reluctant to shine any light on past performance shortfalls, which then makes it difficult to provide education about performance in a client service context. Such reluctance may result in signing up the wrong kind of clients (the impatient kind) and an inability to keep even the right clients during performance declines.
A very successful portfolio manager I have stayed in touch with over the years once said, "Benchmark agnostic? Hell, I’m not an agnostic. If anything, I am a benchmark atheist." Regardless of what label they choose to use, active managers should consider that this is exactly what the most desirable, loyal clients are really looking for: benchmark atheists.
Active Share
Mercer Investments has incorporated active share into the firm’s analysis of individual managers and entire portfolios while many investment firms now monitor active share for all portfolios. What is active share? It is a measure of the level of active management in a portfolio achieved through (1) holding securities not in the index, (2) not holding securities that are in the index and (3) holding stocks in different weights than the index. A portfolio with 0% active share essentially is a pure clone of the index while a portfolio with 100% active share has no holdings in common with the index.
The term was coined based on work by Martijn Cremers and Antti Petajisto in their August 2009 research paper, "How Active is Your Fund Manager? A New Measure that Predicts Performance."3 Cremers and Petajisto concluded that portfolios with higher active share generated better average returns than their lower active share counterparts. Subsequent studies and articles have revealed important nuances around the interpretation of active share:
•
Small-cap portfolios tend to have significantly higher active share. While 80%+ may indicate true active management among large-cap developed equity managers, Cambridge Associates has observed that "95% may be a better cut-off to determine truly active US small-cap managers."
•
Cambridge also concluded that "combining insight from active share and portfolio concentration with tracking error can help investors identify managers that may be better poised for success, with both a better distribution of outcomes and a better average outcome."
•
Undesirable style and market cap drift can increase active share for the wrong reasons. Fidelity Investments has studied the phenomenon of large-cap managers with high active share derived mainly from investing in out-of-mandate smaller-cap stocks.4
In sum, consider the source of active share. Unlike other predictive measures, active share is relatively easy to understand and already has been widely adopted by the consulting community. Even if investment firms choose not to use active share explicitly in their marketing, they can expect to be asked questions about the level and composition of active share in their portfolios.
Ivy Investing
The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets provides inspiration to those of us who still believe in active management. Written by Mebane T. Faber and Eric W. Richardson of Cambria Investment Management, The Ivy Portfolio profiles successful university endowments such as Yale, which came under fire in the aftermath of the financial crisis for its emphasis on equity-oriented, illiquid asset classes. Yale, however, lived to fight another day. In the 20 years ending June 30, 2013, the Yale endowment generated returns of 13.5% per annum relative to 8.4% per annum for the median Cambridge Associates manager — a result that Yale attributes to "disciplined and diversified asset allocation policies and superior active management results."5
The Ivy Portfolio documents how large endowments have achieved investment success through size, relationships, allocations to alternative assets and superior active management — with advice on where individual investors should (and should not) consider using the same strategies.
The Ivy Portfolio is an interesting and enjoyable read not only for investors but also for sales and marketing professionals who want to learn more about the university endowment market.
1.
"Conviction in Equity Investing," a 2012 research study by Hewitt Ennis Knupp. All references to the views of Hewitt Ennis Knupp in this issue of Excess Returns are based on this study.
2.
"Hallmarks of Successful Active Equity Managers," an April 2014 research study by Kevin Ely of Cambridge Associates. All references to the views of Cambridge Associates in this issue are based on this study.
3.
Martijn Cremers and Antti Petajisto, "How Active Is Your Fund Manager? A New Measure That Predicts Performance," Review of Financial Studies 22, no. 9 (August 2009). This article was followed by "Active Share and Mutual Fund Performance," by Antti Petajisto, Financial Analysts Journal, 69, no. 4 (July/August 2013).
4.
"Active Share: A Misunderstood Measure in Manager Selection," Fidelity Investments, February 2014.
Alpha Partners LLC Marketing for Excess Returns®
1062 Oakridge Road South | Park City, UT | 84098
You are receiving this newsletter as a member of the investment community. If you no longer wish to receive it, please respond to this email with “No More Penguins” in the subject line. To subscribe to this newsletter, send an email with your request to info@alphapartners.com. Your privacy is important to us. We will never rent, sell or share any information that you provide.
Monthly insights for investment marketing and sales professionals
November-December 2014
How do true active investment managers sell themselves in a market that has become deeply skeptical regarding claims of active management? This issue of Excess Returns offers advice to active managers seeking differentiation from the crowd of closet indexers.
With best wishes,
Liz Hecht
Founder, Principal and Director of Research
Alpha Partners is an investment marketing firm specializing in research and presentation strategy. Our goal is to create alpha (excess returns) by helping investment firms win, keep and diversify assets under management.
I vividly remember the stab of dismay I experienced the first time I heard the term "benchmark agnostic." I understood that this was a new way to describe active management, but I could not reconcile the concept of agnosticism (lacking in belief, sitting on the fence) to an activity that requires conviction for success. Since that time, "benchmark agnostic" has become a term of art in the investment industry. It is widely used and most people know what it means.
As a human being, I want badly to believe in active management, to believe that the hard work and analytical powers of my fellow humans can generate excess returns. Sustaining this belief these days, however, has become increasingly difficult. The concept of being "agnostic" — the label many active managers now proudly wear — somehow does not convey the requisite conviction. And the rising popularity of active share as a measure of active management has made it easier to uncover the widespread practice of closet indexing among public equity managers. A study of institutionally focused products by Hewitt Ennis Knupp found that demonstrated skill in active equity has steadily declined since the 1990s to the point where "less than 2% of active equity managers have demonstrated evidence of skill net of fees."1
Less than 2%. That is one mighty depressing number. So what if you are an active manager in today’s increasingly skeptical market? How can you convince prospective investors that your strategy is truly active? Here are some suggestions.
Strategies for Selling Active Management
Tell a differentiated story. If your marketing materials and presentations don’t say anything different, how can you convince investors that you are doing anything different? A lot of investment firms claim to manage portfolios that are different from the benchmark, but based on review of their marketing and client communications, it is impossible to determine what these differences might be.
If you’ve got a concentrated portfolio, flaunt it. I have worked with many portfolio managers over the years who initially did not appreciate the marketing power of a concentrated portfolio. Their marketing materials emphasized "in-depth fundamental research" or "excellence in execution" or "a culture of integrity" — all nice to have but difficult to prove and not necessarily differentiating. According to a 2014 Cambridge Associates study, managing concentrated portfolios or a small number of portfolio positions "implies more conviction in each investment … [helping to] focus a manager’s attention and reduce the potential for complacency with smaller positions."2 And yet many concentrated portfolio managers don’t even mention the number of holdings in their communications — or, if they do mention a concentrated strategy, do not explain and consistently reinforce its merits.
Preempt any misperception that your portfolio may be overly diversified. The market’s appetite for concentrated strategies sometimes leads people to forget that portfolio diversification is still often necessary and desirable. In highly volatile, less efficient markets and asset classes, you may need to remind prospective clients that greater diversification does not equate with closet indexing but with more opportunities and less potential risk of capital loss.
Work harder to mitigate human behavior risk. In addition to closet indexing, one of the biggest enemies of active management is human behavior risk, manifested as the stated desire for active management combined with the inability to tolerate the volatility that comes with it. Given human behavior risk, Hewitt Ennis Knupp has recommended that investors treat high-conviction public investment strategies "as if they were illiquid like private investments, and pledge to resist making portfolio changes mid-stream."
From a sales, marketing and client service perspective, I see investment firms spending a lot of time communicating about how they measure and manage investment risk. But they should spend more time communicating in ways that mitigate human behavior risk.
There are a lot of white papers, studies and seminars providing education on the merits and challenges of long-term investing — worthy activities and events all at one remove from the process of getting and keeping clients. But rarely do I see marketing materials with education embedded in the story — education about when a strategy is likely to underperform and why and the benefits of being a patient client. Even if a firm does cover this information in its sales materials, only infrequently is it reinforced clearly and consistently in client service meetings. I suspect this is because, in the heat of battle while selling directly, some firms are reluctant to shine any light on past performance shortfalls, which then makes it difficult to provide education about performance in a client service context. Such reluctance may result in signing up the wrong kind of clients (the impatient kind) and an inability to keep even the right clients during performance declines.
A very successful portfolio manager I have stayed in touch with over the years once said, "Benchmark agnostic? Hell, I’m not an agnostic. If anything, I am a benchmark atheist." Regardless of what label they choose to use, active managers should consider that this is exactly what the most desirable, loyal clients are really looking for: benchmark atheists.
Active Share
Mercer Investments has incorporated active share into the firm’s analysis of individual managers and entire portfolios while many investment firms now monitor active share for all portfolios. What is active share? It is a measure of the level of active management in a portfolio achieved through (1) holding securities not in the index, (2) not holding securities that are in the index and (3) holding stocks in different weights than the index. A portfolio with 0% active share essentially is a pure clone of the index while a portfolio with 100% active share has no holdings in common with the index.
The term was coined based on work by Martijn Cremers and Antti Petajisto in their August 2009 research paper, "How Active is Your Fund Manager? A New Measure that Predicts Performance."3 Cremers and Petajisto concluded that portfolios with higher active share generated better average returns than their lower active share counterparts. Subsequent studies and articles have revealed important nuances around the interpretation of active share:
•
Small-cap portfolios tend to have significantly higher active share. While 80%+ may indicate true active management among large-cap developed equity managers, Cambridge Associates has observed that "95% may be a better cut-off to determine truly active US small-cap managers."
•
Cambridge also concluded that "combining insight from active share and portfolio concentration with tracking error can help investors identify managers that may be better poised for success, with both a better distribution of outcomes and a better average outcome."
•
Undesirable style and market cap drift can increase active share for the wrong reasons. Fidelity Investments has studied the phenomenon of large-cap managers with high active share derived mainly from investing in out-of-mandate smaller-cap stocks.4
In sum, consider the source of active share. Unlike other predictive measures, active share is relatively easy to understand and already has been widely adopted by the consulting community. Even if investment firms choose not to use active share explicitly in their marketing, they can expect to be asked questions about the level and composition of active share in their portfolios.
Ivy Investing
The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets provides inspiration to those of us who still believe in active management. Written by Mebane T. Faber and Eric W. Richardson of Cambria Investment Management, The Ivy Portfolio profiles successful university endowments such as Yale, which came under fire in the aftermath of the financial crisis for its emphasis on equity-oriented, illiquid asset classes. Yale, however, lived to fight another day. In the 20 years ending June 30, 2013, the Yale endowment generated returns of 13.5% per annum relative to 8.4% per annum for the median Cambridge Associates manager — a result that Yale attributes to "disciplined and diversified asset allocation policies and superior active management results."5
The Ivy Portfolio documents how large endowments have achieved investment success through size, relationships, allocations to alternative assets and superior active management — with advice on where individual investors should (and should not) consider using the same strategies.
The Ivy Portfolio is an interesting and enjoyable read not only for investors but also for sales and marketing professionals who want to learn more about the university endowment market.
1.
"Conviction in Equity Investing," a 2012 research study by Hewitt Ennis Knupp. All references to the views of Hewitt Ennis Knupp in this issue of Excess Returns are based on this study.
2.
"Hallmarks of Successful Active Equity Managers," an April 2014 research study by Kevin Ely of Cambridge Associates. All references to the views of Cambridge Associates in this issue are based on this study.
3.
Martijn Cremers and Antti Petajisto, "How Active Is Your Fund Manager? A New Measure That Predicts Performance," Review of Financial Studies 22, no. 9 (August 2009). This article was followed by "Active Share and Mutual Fund Performance," by Antti Petajisto, Financial Analysts Journal, 69, no. 4 (July/August 2013).
4.
"Active Share: A Misunderstood Measure in Manager Selection," Fidelity Investments, February 2014.
Monthly insights for investment marketing and sales professionals
October 2014
It is potentially the most powerful page in any presentation book. It can articulate a firm’s identity in distinctive, memorable terms. It inspires calm fortitude during market upheavals, and it often provides points of intellectual alignment with clients and consultants. This issue of Excess Returns takes a fresh look at one of the most undervalued, misunderstood elements in the investment marketing tool kit: the investment philosophy statement.
With best wishes,
Liz Hecht
Founder, Principal and Director of Research
Alpha Partners is an investment marketing firm specializing in research and presentation strategy. Our goal is to create alpha (excess returns) by helping investment firms win, keep and diversify assets under management.
The investment philosophy statement defines the beliefs that guide investment decisions. It is the first and possibly the most important of “the four Ps” that we’ve all been taught are critical in any institutional-quality presentation: philosophy, process, people and performance. Yet many investment firms still either do not seem to have a philosophy statement or offer up as a “philosophy” a list of truisms lacking in character, substance or distinction. In 2007 I wrote an article, Philosophy for Investment Managers, about the role of the philosophy statement — what it is and is not — for the Art & Science section of our firm’s website. Since that time, much has changed.
The Evolving Role of the Philosophy Statement
I see three new trends that investment company professionals should consider when articulating their beliefs about investing:
1.
Your target audience has beliefs, too. In a review of 2004 marketing literature for investment consulting firms, I found relatively few references to “investment beliefs” or “investment philosophy” — and virtually all of these references related to evaluating an investment manager’s philosophy as opposed to communicating the consulting firm’s own philosophy. Today, prominent investment consulting firms clearly articulate their beliefs about how to invest successfully, and asset owners such as CalPERS and the Ontario Teachers’ Pension Plan also have published carefully considered beliefs about investing.
Familiarity with the beliefs of your audience may confer an advantage during meetings and formal presentations. At the very least, such knowledge may save time. (Thinking about a visit to Timbuktu to flog that active US large-cap equity strategy? A quick check of Timbuktu’s Investment Policy Statement might save you a trip, as Timbuktu does not believe in active management for the most efficient areas of the market.) This new emphasis on beliefs among consultants and asset owners gives investment firms another important way to get to know their audience.
2.
The investment time horizon is increasingly important. Time is the context in which every investment philosophy plays out. According to a dataset of 40 pension funds and asset managers with publicly reported investment beliefs, however, only 6.4% of pension funds and 5% of asset managers address the time horizon when describing their philosophy of investing.1 In my experience, virtually all investment managers across asset classes claim “a long-term view” as a competitive advantage. But what does this really mean (and how big an advantage can it be if everyone else lays claim to the very same advantage)? While the market is filled with practitioners claiming to maintain a long-term discipline, one measure shows the average holding period for stocks declining steadily from 33 months in 1980 to 26 months in 1990 to 14 months in 2000 to just six months in 2010.2
This focus on short-term results might mean that long-term holders have become a bunch of complacent suckers, mere prey marching into the maw of high-frequency traders. Or it might mean that a long-term view has become a more significant competitive advantage, particularly in the current market (as I write this, the Dow is down over 300 points today after being up almost 300 points yesterday). Thoughtful, clearly articulated beliefs about the investment time horizon have become more important in crafting the investment philosophy statement, especially now when markets are so volatile and concern is rising over the tyranny of short-termism.
3.
Asset owner and consultant belief systems often explicitly address Environmental, Social and Governance (ESG) principles. My 2007 article cited the following as an example of a strong philosophy statement: “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.” More recently, in 2012, Towers Watson stated its belief that “environmental, social and governance factors have material influences on risks and returns, which investors may find difficult to price fairly. This creates an information advantage for those investors who are skilled at pricing these risks accurately.”3
As of this writing, there are 1,300 signatories to the United Nations Principles for Responsible Investment, including asset owners, investment managers and professional service partners. Even if you are meeting with an institutional investor or consultant that is not a signatory as an organization, certain influential individuals within that organization may well be ardent supporters. One of these individuals might ask how an investment firm considers ESG factors in its decision process. Given rising support for Environmental, Social and Governance investment principles, investment firms can increasingly expect questions about their beliefs with respect to ESG investing.
Despite these new developments, much has remained the same. Investment managers still tend to give their beliefs short shrift, stating the obvious (an active equity manager who believes the market is inefficient) while failing to note potentially strong sources of differentiation. When belief statements are robust, they tend to be too long or larded with the uninspiring, often confusing language of academia. Actions, strategies and investment styles still are put forward as beliefs (“We are a value investment manager” is not a belief). Proof linking beliefs to results remains rare. And client review meetings, while long on portfolio characteristics and performance, rarely tie this information back to the belief system clients bought when they hired the manager. All of which adds up to a rich field of marketing opportunity for investment firms that can clearly articulate a differentiated investment philosophy and tie their beliefs back to performance.
Beyond Short-Termism
CalPERS has stated the belief that “a long investment horizon is a responsibility and an advantage.” And in their 2014 Harvard Business Review article, “Focusing Capital on the Long Term,” Dominic Barton and Mark Wiseman propose emphasis on “metrics like 10-year economic value added, R&D efficiency, patent pipelines, multiyear return on capital investments and energy intensity of production … in assessing a company’s performance over the long haul.” Many of my public equity clients, however, who believe their performance should be evaluated over at least a three- to five-year time horizon, have told me that in reality three years is a luxury. A 2013 McKinsey Quarterly survey of 1,000 board members and C-suite executives indicates that while a majority believed that a longer time horizon would positively affect corporate performance, they nonetheless felt pressured to demonstrate strong financial results in two years or less.
Mr. Barton, the global managing director of McKinsey & Company, and Mr. Wiseman, the president and CEO of the Canada Pension Plan Investment Board (CPPIB), note that “one reason why private equity firms buy publicly traded companies and take them private” is to avoid short-term performance pressure. In “Focusing Capital on the Long Term,” they write: “Research, including an analysis by CPPIB, indicates that over the long term (and after adjustment for leverage and other factors), investing in private equity rather than comparable public securities yields annual aggregate returns that are 1.5% to 2.0% higher, even after substantial fees and carried interest are paid to private equity firms.”
Proposed remedies abound for what Mr. Barton has called “the tyranny of short-termism”: superior voting rights for longer-term holders, compensation plans for company executives tied to long-term performance with penalties for underperformance and boards structured to diminish cronyism, to mention only a few.
Messrs. Barton and Wiseman zero in on the source of the problem and the solution: asset owners need to start acting like owners. At present, they write, “many asset owners will tell you they have a long-term perspective. Yet rarely does this philosophy permeate all the way down to individual investment decisions.” In other words, institutional investors need to start putting their beliefs into action. Or, put more bluntly, it’s time to walk the talk, especially when fiduciary responsibilities of the world’s largest asset owners stretch over generations.
Investment Beliefs, The Book
“I’d be a bum on the street with a tin cup if the markets were always efficient.”
— Warren Buffett
“I’d compare stock pickers to astrologers, but I don’t want to bad-mouth the astrologers.”
— Burton Malkiel
“We’re passive, but we’re not stupid.”
— Dimensional Fund Advisors’ co-founder David Booth
In 2011, Kees Koedijk and Alfred Slager wrote the book Investment Beliefs: A Positive Approach to Institutional Investing, which I believe will become required reading in our industry. Mr. Koedijk is Professor of Financial Management and Dean of the Tilburg School of Economics and Management, The Netherlands, and Mr. Slager, the former Chief Investment Officer at Stork Pension Fund, is director of CentER Applied Research, Tilburg University. The authors point to beliefs as key to achieving clarity of purpose in a world where volatility is the norm. In such a world, a clear set of investment beliefs — a lighthouse in a stormy sea, to borrow the book’s cover image — becomes critical.
One can read this book page by page or jump around in search of specific information. There are useful summaries and case studies spanning organizations from different countries and industries. I particularly liked the chapters that demonstrate the dispersion of beliefs around topics such as inefficiencies, risk premiums, investment horizon and sustainability. Each of these chapters includes a case study, the theory behind different beliefs and debates to be aware of; the quotes above in the chapter on inefficiencies, for example, dramatize the range of beliefs around active versus passive investing.
Alpha Partners LLC Marketing for Excess Returns®
1062 Oakridge Road South | Park City, UT | 84098
You are receiving this newsletter as a member of the investment community. If you no longer wish to receive it, please respond to this email with “No More Penguins” in the subject line. To subscribe to this newsletter, send an email with your request to info@alphapartners.com. Your privacy is important to us. We will never rent, sell or share any information that you provide.
Monthly insights for investment marketing and sales professionals
October 2014
It is potentially the most powerful page in any presentation book. It can articulate a firm’s identity in distinctive, memorable terms. It inspires calm fortitude during market upheavals, and it often provides points of intellectual alignment with clients and consultants. This issue of Excess Returns takes a fresh look at one of the most undervalued, misunderstood elements in the investment marketing tool kit: the investment philosophy statement.
With best wishes,
Liz Hecht
Founder, Principal and Director of Research
Alpha Partners is an investment marketing firm specializing in research and presentation strategy. Our goal is to create alpha (excess returns) by helping investment firms win, keep and diversify assets under management.
The investment philosophy statement defines the beliefs that guide investment decisions. It is the first and possibly the most important of “the four Ps” that we’ve all been taught are critical in any institutional-quality presentation: philosophy, process, people and performance. Yet many investment firms still either do not seem to have a philosophy statement or offer up as a “philosophy” a list of truisms lacking in character, substance or distinction. In 2007 I wrote an article, Philosophy for Investment Managers, about the role of the philosophy statement — what it is and is not — for the Art & Science section of our firm’s website. Since that time, much has changed.
The Evolving Role of the Philosophy Statement
I see three new trends that investment company professionals should consider when articulating their beliefs about investing:
1.
Your target audience has beliefs, too. In a review of 2004 marketing literature for investment consulting firms, I found relatively few references to “investment beliefs” or “investment philosophy” — and virtually all of these references related to evaluating an investment manager’s philosophy as opposed to communicating the consulting firm’s own philosophy. Today, prominent investment consulting firms clearly articulate their beliefs about how to invest successfully, and asset owners such as CalPERS and the Ontario Teachers’ Pension Plan also have published carefully considered beliefs about investing.
Familiarity with the beliefs of your audience may confer an advantage during meetings and formal presentations. At the very least, such knowledge may save time. (Thinking about a visit to Timbuktu to flog that active US large-cap equity strategy? A quick check of Timbuktu’s Investment Policy Statement might save you a trip, as Timbuktu does not believe in active management for the most efficient areas of the market.) This new emphasis on beliefs among consultants and asset owners gives investment firms another important way to get to know their audience.
2.
The investment time horizon is increasingly important. Time is the context in which every investment philosophy plays out. According to a dataset of 40 pension funds and asset managers with publicly reported investment beliefs, however, only 6.4% of pension funds and 5% of asset managers address the time horizon when describing their philosophy of investing.1 In my experience, virtually all investment managers across asset classes claim “a long-term view” as a competitive advantage. But what does this really mean (and how big an advantage can it be if everyone else lays claim to the very same advantage)? While the market is filled with practitioners claiming to maintain a long-term discipline, one measure shows the average holding period for stocks declining steadily from 33 months in 1980 to 26 months in 1990 to 14 months in 2000 to just six months in 2010.2
This focus on short-term results might mean that long-term holders have become a bunch of complacent suckers, mere prey marching into the maw of high-frequency traders. Or it might mean that a long-term view has become a more significant competitive advantage, particularly in the current market (as I write this, the Dow is down over 300 points today after being up almost 300 points yesterday). Thoughtful, clearly articulated beliefs about the investment time horizon have become more important in crafting the investment philosophy statement, especially now when markets are so volatile and concern is rising over the tyranny of short-termism.
3.
Asset owner and consultant belief systems often explicitly address Environmental, Social and Governance (ESG) principles. My 2007 article cited the following as an example of a strong philosophy statement: “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.” More recently, in 2012, Towers Watson stated its belief that “environmental, social and governance factors have material influences on risks and returns, which investors may find difficult to price fairly. This creates an information advantage for those investors who are skilled at pricing these risks accurately.”3
As of this writing, there are 1,300 signatories to the United Nations Principles for Responsible Investment, including asset owners, investment managers and professional service partners. Even if you are meeting with an institutional investor or consultant that is not a signatory as an organization, certain influential individuals within that organization may well be ardent supporters. One of these individuals might ask how an investment firm considers ESG factors in its decision process. Given rising support for Environmental, Social and Governance investment principles, investment firms can increasingly expect questions about their beliefs with respect to ESG investing.
Despite these new developments, much has remained the same. Investment managers still tend to give their beliefs short shrift, stating the obvious (an active equity manager who believes the market is inefficient) while failing to note potentially strong sources of differentiation. When belief statements are robust, they tend to be too long or larded with the uninspiring, often confusing language of academia. Actions, strategies and investment styles still are put forward as beliefs (“We are a value investment manager” is not a belief). Proof linking beliefs to results remains rare. And client review meetings, while long on portfolio characteristics and performance, rarely tie this information back to the belief system clients bought when they hired the manager. All of which adds up to a rich field of marketing opportunity for investment firms that can clearly articulate a differentiated investment philosophy and tie their beliefs back to performance.
Beyond Short-Termism
CalPERS has stated the belief that “a long investment horizon is a responsibility and an advantage.” And in their 2014 Harvard Business Review article, “Focusing Capital on the Long Term,” Dominic Barton and Mark Wiseman propose emphasis on “metrics like 10-year economic value added, R&D efficiency, patent pipelines, multiyear return on capital investments and energy intensity of production … in assessing a company’s performance over the long haul.” Many of my public equity clients, however, who believe their performance should be evaluated over at least a three- to five-year time horizon, have told me that in reality three years is a luxury. A 2013 McKinsey Quarterly survey of 1,000 board members and C-suite executives indicates that while a majority believed that a longer time horizon would positively affect corporate performance, they nonetheless felt pressured to demonstrate strong financial results in two years or less.
Mr. Barton, the global managing director of McKinsey & Company, and Mr. Wiseman, the president and CEO of the Canada Pension Plan Investment Board (CPPIB), note that “one reason why private equity firms buy publicly traded companies and take them private” is to avoid short-term performance pressure. In “Focusing Capital on the Long Term,” they write: “Research, including an analysis by CPPIB, indicates that over the long term (and after adjustment for leverage and other factors), investing in private equity rather than comparable public securities yields annual aggregate returns that are 1.5% to 2.0% higher, even after substantial fees and carried interest are paid to private equity firms.”
Proposed remedies abound for what Mr. Barton has called “the tyranny of short-termism”: superior voting rights for longer-term holders, compensation plans for company executives tied to long-term performance with penalties for underperformance and boards structured to diminish cronyism, to mention only a few.
Messrs. Barton and Wiseman zero in on the source of the problem and the solution: asset owners need to start acting like owners. At present, they write, “many asset owners will tell you they have a long-term perspective. Yet rarely does this philosophy permeate all the way down to individual investment decisions.” In other words, institutional investors need to start putting their beliefs into action. Or, put more bluntly, it’s time to walk the talk, especially when fiduciary responsibilities of the world’s largest asset owners stretch over generations.
Investment Beliefs, The Book
“I’d be a bum on the street with a tin cup if the markets were always efficient.”
— Warren Buffett
“I’d compare stock pickers to astrologers, but I don’t want to bad-mouth the astrologers.”
— Burton Malkiel
“We’re passive, but we’re not stupid.”
— Dimensional Fund Advisors’ co-founder David Booth
In 2011, Kees Koedijk and Alfred Slager wrote the book Investment Beliefs: A Positive Approach to Institutional Investing, which I believe will become required reading in our industry. Mr. Koedijk is Professor of Financial Management and Dean of the Tilburg School of Economics and Management, The Netherlands, and Mr. Slager, the former Chief Investment Officer at Stork Pension Fund, is director of CentER Applied Research, Tilburg University. The authors point to beliefs as key to achieving clarity of purpose in a world where volatility is the norm. In such a world, a clear set of investment beliefs — a lighthouse in a stormy sea, to borrow the book’s cover image — becomes critical.
One can read this book page by page or jump around in search of specific information. There are useful summaries and case studies spanning organizations from different countries and industries. I particularly liked the chapters that demonstrate the dispersion of beliefs around topics such as inefficiencies, risk premiums, investment horizon and sustainability. Each of these chapters includes a case study, the theory behind different beliefs and debates to be aware of; the quotes above in the chapter on inefficiencies, for example, dramatize the range of beliefs around active versus passive investing.