Q:  What’s the investment philosophy of the fund?

A: This is a fund of funds and our philosophy is based on the belief that most returns of the underlying funds are generated not by the skill of the manager but by the style in which they manage money. Once that’s stripped out, what’s left is the manager skill and that’s what we’re really looking for.

When we’re looking for the managers, our first and foremost goal is to understand what the key drivers of their performance are. We keep the process simple in the sense that we look at individual countries rather than at funds that invest in different asset classes and different geographical regions.

For instance, when we consider the U.K. market, our starting point would be the fund’s particular investment style, if it is driven by value or by growth philosophy. Second, we look at whether they invest in larger or smaller companies, in a mix between the two, or in a mix between investment style and market cap. We use a quantitative model to get to the core of why a fund performs in the way it does.

We find relatively few managers able to add value through judicious stock picking. Our work suggests that managers perform well or badly because they stick to a style that comes in and out of vogue, not because of any particular skill they’ve got. So our starting philosophy is that there are many external factors that are influencing the fund’s performance and as such simple short term performance itself can be relatively unimportant.

Q:  How do you translate that philosophy into an investment strategy and process?

A: We’ve built an in-house manager and fund research program, which tracks the returns of the manager over a long period of time and compares them against different indices. It is country dependent and the program is basically trying to find the best fit for the funds return versus those indices.

For example, most funds don’t just buy small-cap stocks; they usually blend different styles of stocks across market capitalization ranges. But if the fund continuously acts like a small-cap value index, then our program would suggest that the portfolio is biased toward smallcap value investing style. Of course, we would check that against the current holdings to see if the fund looks interesting. If we find that most of the time the investment process at the fund is consistent with the investment charter predicted we will organize a meeting with the fund manager.

Q:  How long-term is your investment horizon?

A: The longer the better. What differentiates our strategy is that we actually track the managers over time. In the U.K. there’s quite a lot of turnover of people moving between companies. We’d piece together their track record and we can re-build manager track record that goes back over 15 years, even if the manager has managed money at five different companies. We believe that it’s really important to track the people who make the difference in the portfolio rather than just to look at how the portfolio has changed over time. A lot of the performance fluctuation might be just because the manager has changed.

Within the philosophy, we do actually believe that the individuals that can add value above and beyond their styles are very, very rare. However if you can pinpoint the added value that came through stock selection, the figure itself is quite consistent. The bottom line is that if you’re a good stock picker, you tend to consistently add value over time. Your style drives up major out or under performance as it falls into or out of favor, but the actual stock picking abilities of the manager tend to be stable over time. When you just look at the performance tables, you see style and size disrupting the return.

Q:  Once you discern this type of performance, how do you proceed in selecting the managers?

A: The key thing is the stock selection ability, so when we run the funds through the model, we test how much value is being added above and beyond the specific style. When we rank and compare funds, we’re also looking at the consistency of added value through stock selection. We measure both the outperformance of stock selection and the volatility of that outperformance. The two combined lead us to whether we are interested or not in this fund.

If we find managers with good stock selection abilities and consistency over a longer period of time, our next job would be to meet those managers and to understand their investment process. We want to know why they’ve produced these returns, whether our expectations are in line with what he thinks, and whether they’ve just been lucky or they have a process that can lead to consistent outperformance going forward. We’re not that interested in their macroeconomic views because we believe that the stockpicking area is where they add value.

We also heavily focus on the incentivization of the team, whether the manager or the team own the company. Quite often when you find a relationship that goes beyond being a paid fund manager with a bonus, there’s a massive extra incentivization to perform. We believe that there’s a strong tie between future performance and how well the individual or the team is rewarded. That’s very attractive to us because in such cases they are really after good performance, not after just growing assets.

Of course, if you produce performance you tend to grow the assets as well, but it’s about the right balance. If it is all about growing the assets, the manager may be spends too much time on the road selling the product, which obviously isn’t good from a fund management perspective. We want the managers to sit at their desk doing their day job. So we’re trying to see if the key is performance or the size of assets under management. We’re more interested in funds where the manager is incentivized for performance and we often invest in some of the smaller U.K. boutique fund management groups, where if you don’t perform, you don’t get assets, and you go out of business.

Q:  How many managers do you keep on your radar and how many do you invest in?

A: There aren’t that many fund managers that make it through our screening process. Probably less than 10% of the managers that we sift through actually look attractive and worth to be seriously considered for the portfolio. We do have a B list, but when we find a good fund manager we tend to invest with him over a very long period of time. The portfolio turnover is very low and the B list is there as a backup.

Including the fund management division and the research department that is providing a lot of information to our clients, I’d say that we visit between 250 and 300 managers a year. Across all the different strategies, we probably have about 50 managers, while there are about 3,000 funds out there which we could buy. In the U.K. we’ve got a sector called UK Equity Income, which has slightly higher yielding orientation and we only have 10 managers in that particular strategy. In the Special Situations fund we have about 25 managers.

Q:  What would be a reason to sell a fund?