The accountant will file your tax return, the lawyer will draft your will, and the dentist will fill your cavity.
We start off by trusting that they have the skills and experience to do the job well, but we also get to see at least some of what they do and have some appreciation of their approach, their application, and the results. Their work is tangible.
In the case of professional investment managers, what they do is not well understood by most. This is at least partly because the traditional route to an investment manager is through an intermediary such as a financial adviser. The investment manager deals with the adviser and the adviser manages the details of your investment.
There’s not much visibility of the process occurring behind the curtain. So, it’s hardly surprising that most investors have little understanding of what an investment manager actually does.
Add to that the fact that, unlike lawyers, doctors, detectives, private investigators, and vampires, investment managers aren’t really represented in television shows and movies.
OpenInvest is changing that (not the TV shows and movies bit – yet) and allowing clients direct access to professional investment managers.
Different investment managers have different skills
An investment management company is staffed with a team of highly-educated, critical thinkers. Some spend long days analysing their portfolios, others spend even longer days investigating potential investments; the common goal is to achieve the optimal financial outcomes for their clients.
Success is all about making decisions from a constant stream of new information. People with deep analytical skills and the ability to look both at the data and beyond the data make good investment managers.
You might have heard of ‘passive’ management. Passive managers don’t need to analyse companies or markets, they just follow what’s happening in the index, so they’re faced with decisions concerning implementation rather than portfolio construction or stock selection.
On the other hand, ‘active’ managers make decisions on how best to manage a portfolio of investments to achieve their clients’ objectives. They face the task of collating and organising vast amounts of information. Sorting the signal from the noise is what these teams of professionals do best. Ultimately, it’s the conclusions drawn and decisions that are made from deep analysis that lead to investment performance that achieves the goals of the client.
The never-ending flow of data
Data flows constantly through the markets and it can include longer‑term economic, demographic, political, societal and technological trends as well as much shorter‑term, more volatile information about companies or commodity prices. Data is a key input to the investment management process but it’s the ability to transform data into information that is key to investment success.
Due to the sheer volume of information that needs to be processed and its inherent variability, investment managers are required to make long-term decisions from rapidly changing data. That’s no easy feat.
The most important thing to understand about an investment management company is that it is a team of people, each with a specific job, working in combination to make optimal investment decisions on behalf of their clients.
A team of specialists
Economic strategists will advise the team on worldwide macro trends. They’ll look at whether governments will be introducing laws that promote economic activity or whether there are societal or political trends that will have the effect of slowing the economy.
Security analysts will develop deep knowledge of companies, actively sourcing new material. They travel regularly, speaking with management, attending investor briefings, meeting government officials, local market commentators and business leaders, to understand the prospects for each country and the companies based there.
Portfolio managers lead the collaboration to build robust portfolio solutions using the material from the team.
These roles are common to most investment teams, but a high‑performing team adds one key ingredient to the process: judgement. It’s not something that’s easy to come by, and certainly can’t be bought. It’s the ability to see behind the veneer and to blend knowledge and experience to draw insightful conclusions.
Spreadsheets and reports don’t give a full picture
Here's an example of the skills and judgement of an analyst I know. He’d visit a mine site and would count the number of spare truck tyres available and talk to the mine manager and mining crew to get a true feeling for what was happening, literally, at the coalface. Disengaged crew, poor catering, or problems with logistics or the supply chain became apparent to him and informed his analysis of the whole operation.
Simply listening to the sanitised words of the investor relations manager was never enough for him, and his insight often paid dividends for investors. On occasion, his long history of conversations with senior management was able to reveal subtle changes in their mood or bearing which were used to make qualitative appraisals about the morale within the organisation.
The ability to see more than the numbers is a finely-developed skill. Two investment teams may look at the same information and draw different conclusions from it, because each is applying their own judgement based on their combined skills and experience. The best analysts can feel the pulse of a company and make assessments from more than just the numbers in an annual report. Good judgement comes with the experience that can only be earned through years of hard work and learning.
This experience becomes the information edge that a manager uses to deliver outstanding results for their clients. It’s where an investment manager earns their fee since it’s not something an ‘ordinary’ investor can do.
Investment managers have to make decisions all the time
There’s a hierarchy of investment decisions to be made in a global, multi-asset portfolio — each becoming more specific and requiring more detailed information.
The portfolio’s broad asset allocation comes first, deciding among the major asset classes to build a solid foundation to achieve the broad portfolio objectives (see more on OpenInvest's four model portfolio categories). Then, within each asset class the allocation decisions begin with countries, then market sectors, then individual companies.
While generic country and sector allocations may be a guide, the portfolio manager must spread the assets broadly enough for diversification but with concentrations in those countries assessed to be the better performers. These allocations are made based on their understanding of global economic criteria, including comparative monetary policy analysis and knowledge of demographic trends and local political developments.
Sectoral analysis seeks to identify the best-performing sectors of each economy. Within each market sector decisions about the relativities among individual companies, using both external research and in-house acumen, will also be needed.
The process of investment management is very much one of ongoing iteration. Conditions and opinions are constantly changing. Investment management is not ‘set and forget’; there’s continual scrutiny and rebalancing of the portfolio to keep it on target.
But continual analysis and monitoring don’t always translate into trading. Good managers know the benefits of a well-positioned portfolio and, importantly, they know when not to trade. Trading incurs transaction costs which chip away at returns. Even if they’re not trading, portfolio managers are still at work collating, sorting and analysing, always looking for opportunity.
So, there’s a quick look inside an investment manager. OpenInvest enables investment managers to communicate to investors how they’re working, what they’re doing, what decisions they’re making, how they’re thinking about a range of issues, and what’s driving their judgement. Understanding what’s going on behind the scenes helps build trust and confidence for investors.
Hard work (and teamwork) generally pays off
A top-performing investment management business is a team effort: a large number of specialists, often in different offices and countries, collaborating to achieve a common goal. For an investment team, it’s the ability to consistently collect, analyse and distil the most important parts from a constant stream of information, and then apply their experience and judgement to that information, which sets them apart from their competition and delivers successful outcomes for their clients.
* * * * * * * *
About the author:
Angus McLeod is a 25-year veteran of the financial markets, having spent 12 years as an equity portfolio manager. He holds a degree in Economics, a master’s in Applied Finance, and is a CFA charter holder and a CIMA® certificant. Angus is a lecturer in the Master of Finance course at RMIT University.