As a “manager of managers”, CBIS hires institutional investment
management firms to manage our institutional funds and separately
managed portfolios. Our SRI program is an overlay on our managers’
investment programs. Our investment process, therefore, consists of the
selection, evaluation and, if need be, the replacement of the
investment managers we hire.
CBIS’ investment process consists of three basic stages, 1) manager
selection, 2) monitoring and evaluation, and, based on the manager’s
results, 3) retention or replacement. We constantly review our
managers, continuously research new managers (in order to maintain a
short list for each style in the event replacement is required), and
hone our analytical framework for selecting managers who can succeed
over the long term.
CBIS seeks out a number of identifiable characteristics in the managers we hire in order to ensure that they are a good fit with our overall investment philosophy, and to gain our required comfort level in their ability to meet our expectations for value added over a market cycle. The characteristics include:
- An emphasis on fundamental research
- A strong 3- to 5-year track record
- An understandable, sustainable investment process
- Continuity of personnel
- Suitability for our version of SRI
- Complementary investment approaches
Monitoring and Evaluation
Once a manager is hired, we follow a rigorous, systematic process for ongoing evaluation. This process includes:
- daily access to portfolio holdings
- daily review of portfolio performance
- monthly review of portfolio transactions
- quarterly performance attribution analysis
- ongoing meetings with manager prospects
We have the ability to conduct a daily review of exposure to any given security if we have concerns with it, although in practice this is rarely necessary. Quarterly performance attribution analysis, however, is a critical and fundamental aspect of the monitoring process. Each manager prepares a quarterly report that shows how they achieved their added value or their underperformance, and that assesses the portfolio’s exposures to various risks in the marketplace. This report helps us determine whether the manager is pursuing the strategy for which they were hired.
When a Manager Underperforms
Monitoring and evaluation are most visible, of course, when a manager is underperforming. And a reality of investing is that all good managers will experience periods of underperformance when their approaches are temporarily out of favor, or when speculative surges in the market temporarily eclipse the attractiveness of a long-term, quality-oriented investment approach. Our process is structured to create a systematic and methodical framework for evaluating periods of underperformance, and for ensuring that the retention/replacement decision is made rationally and analytically, not emotionally. Our objective is to give managers in whom we can retain confidence the time to turn results around, and to replace managers when a breakdown of process or of organizational structure has occurred, where we lack confidence in their ability to recover performance in subsequent periods.
Retention or Replacement
At some point we have to reach a determination: Do we retain an underperforming manager? Can the firm still meet our expectations for added value over the long term? Would we hire this manager today? There is no formula for this decision. Inevitably, it requires judgment based on our assessment of quantitative and qualitative factors, and on our conclusions about the reasons for underperformance. If we have confidence in the people at the firm, if their investment process remains intact, we can be patient. However, as time goes on, it’s harder to recoup underperformance. One way we assess this is to look back at the past. Has this firm suffered prior periods of underperformance? Has it been able to recoup underperformance in subsequent periods? If so, this influences our thinking. A large-cap manager termination can cost 0.5% to 1% in total return, and a small-cap or international manager change can run 2% or more. If we have to make a change, we try to mitigate these costs by using a transition manager. Changing managers is costly. None the less, we are prepared to do it when our best judgment argues for it.