We believe the proper assessment of manager performance effectively separates luck from skill and confirms a repeatable process. This can be very tough to achieve so diversification is crucially important. Finding individuals with the ability and temperament to be a capital allocator is key. One of the best starting points is incentives. We insist that managers must have a substantial part of their net worth in the fund, which ensures fund performance is job one and not fee generation.
We avoid complex or highly levered investments. History has clearly demonstrated that leverage and illiquidity combined can be deadly. And one should only invest in a venture that is completely understood. The majority of fund disasters are from incomprehensible strategies and we often wonder who really understood them. A culture that allows participants the freedom to say they don't understand something avoids this form of group-think. Therefore, we begin our assessment of manager performance with mangers engaged in strategies we completely understand and who have significant incentive for investment success.
Quantitative analysis can confirm those managers who have demonstrated good consistency and asymmetry of returns. This is quite different from simply the highest return. Comparing mandates properly requires a very clear understanding of the underlying strategies and investments. With this it should be reasonably straightforward to establish accurate peer groups of managers by mandate, securities traded and other criteria. These can be compared with established benchmarks to see if active management is actually worth paying for. There are thousands of funds on the market but insisting on longer, more credible track records reduces the field to a manageable number. The next question is how their results were achieved.
The qualitative assessment is much more difficult and tends to come from experience that is sometimes hard won. Every company’s marketing pitch sounds good but the main point is whether the manager’s investment philosophy or logical process is sensible in their chosen field. Does the manager process information in a superior way? A clearly defined investment universe addressed by a cohesive long-standing team tends to be able to achieve better results. We are very wary of over-confidence. Therefore, we believe proper manager assessment links manager incentives with an understandable mandate, demonstrated results and a good team.
We currently invest in 23 hedge funds and 77 funds overall, which includes ETFs and traditional pure-long funds. This reflects our hybrid portfolio management approach that effectively combines traditional and alternative investments. Our investment team includes Manuel Carrelet, Keith Tomlinson and Patrik O'Boyle. We conduct over 110 manager meetings annually in conjunction with our Canadian partners at Toronto-based Arrow Capital Management. We focus on funds under $1 billion of assets, which is large enough to offer efficient operations but not so large that returns are weighed-down by market impact.