Should investors focus on performance or process when selecting managers?

Pick up any financial periodical, or watch financial media, and you’ll eventually get acquainted with some registered investment advisor that’s recently “outperformed” the market.

It’s not surprising. These news intermediaries are in the business of attracting eyeballs; they wouldn’t cover such stories if they weren’t appealing to end consumers. We are not trying to disparage the investing public.  Greed is a basic human emotion and it’s our capitalist nature to satisfy the urge to improve wealth.

However, investors have a tendency to look at recent performance and presume those returns will continue into the future. In the trade, we call this looking at ex-post returns, or after-the-fact returns. We contend that just because you’re “hot” doesn’t mean you’ll stay hot. Think of a gambler that goes to the blackjack table and continuously hits on 18, finishing the night with more money than they started. A novice observer might conclude that the gambler demonstrated an innate skill. Perhaps. But common sense (if you know the game) and simple probability analysis would indicated that the gambler was simply very lucky and that such a strategy could not generate sustainable winnings.

At Atlas Capital, we contend that investors don’t get paid enough (in the form of return) to compensate for active management fees. It’s not that we believe there are no talented active managers, it’s simply that they’re extremely difficult to identify (more so in the equity space than in fixed income) on an ongoing basis.  Several quarters of success does not extrapolate into long term success. The recent SPIVA (Standard & Poor’s Indices Versus Active Funds) study indicated more than 72% of funds performed worse than their benchmark over the last five years. In fact, numerous studies have shown that manager outperformance persistency wanes as time passes. For the interested reader, we’ve listed at the bottom a few recent studies on the subject.  The graph below is taken from one of those studies.

So, if it’s folly to identify exceptional active managers based on past performance, how are you supposed to pick one? That’s just it, you can’t. Ideally you want to know what the manager’s expected return will be and base your analysis on that information. But how do you get that data when the managers themselves probably can’t tell you? A few quarters of performance is an insufficient observation set to determine a manager’s expected return. In the vernacular this is ex-ante return analysis, or before-the-fact return.

At Atlas we don’t portend to have clairvoyant investment skill. What we do have is decades of data on equity returns and empirical evidence of what investment factors have contributed to portfolio returns over those time frames. Such a robust observation set allows us to reasonably estimate expected returns. Rather than trying to guess which stock will be hot next quarter, we employ a systematic asset selection and portfolio construction methodology based on academic theory and practitioner testing. We invest incorporating long term time frames, not quarter to quarter. No one can guarantee the future, but our expectations are to exceed benchmark returns by 2%-3% on an annualized basis net of all fees.

Footnotes and additional reading:



3. the Benchmark_March2012.pdf




* All investments involve risk and various investment strategies will not always be profitable. Some of the portfolio performance could be attributed to the broad market performance, while additional credit, in our opinion, should be given to the individual managers’ investment strategy and risk management processes. Performance should never be the sole consideration when making an investment decision. Past performance does not guarantee future results.