Cons
■Cost. The expansive databases and increased functionality can be ex- pensive. Many systems are available with price tags under $10,000 per annum, but some have price tags significantly higher.
■Accuracy. While most data contained in these databases is accurate, I have often found that information I get from the databases differs from information sent to me by the underlying investment managers.
To put this comment in perspective, let’s explore how information typ- ically gets into a database. The typical database provider asks the man- agers listed in its database to provide specific information to it by a specific date and in a specific format. This could be via e-mail or through direct entry on the database firm’s web site. The manager—
not the database firm—is responsible for the accuracy of the informa- tion. The database firm is responsible for taking the reams of information that it receives and accurately transfering it to its data- base. Some investment managers may unknowingly provide incorrect information about their firms/products to the database provider. Some might intentionally provide misleading information.
■Timing. Database providers do a commendable job of getting, compil- ing, and updating their databases on a monthly and quarterly basis, but the fact is that it does take some time to do all of this and some in- vestment managers are not able to get their updated information in- cluded in the database. To remedy this, database providers often update their databases in several traunches.
eral of their investment professionals in the past week (they left to start up their own hedge fund). After meeting with the remaining team members at DVA, the Fund’s investment team decided to fire DVA and find a replace- ment immediately. The Fund would normally look at its small-cap value bench, but found out that each of the bench managers had recently closed their small-cap value products to new assets (this is a common occurrence in the small-cap asset class).
As a result, the Fund’s investment team needs to conduct a search from scratch. They decide to run screens using a third party database to aid the search process. However, before any screen can be run, a discussion of the Fund’s objective is necessary. The Fund’s broad objective is to hire equity managers that are well established in their particular asset classes (“lead- ers,” as the Fund’s name clearly states). The Fund is benchmarked against the Wilshire 5000 Equity Index, an index that represents the total U.S. eq- uity market. As a result, the Fund is permitted to invest in equities that range from small-cap to mid-cap to large-cap.
Screen Objective
Find a short list of U.S. small-cap value products for possible inclusion in the Fund. The manager is a replacement for DVA. The size of the alloca- tion will be approximately $20 million (based on the current market value of DVA’s portfolio).
There are five minimum manager requirements for inclusion in the search:
1. Three-year track record.
2. Three-year Sharpe ratio in the top quartile among peer group.
3. Portfolio that will complement the fund’s small-cap growth compo- nent.
4. Maximum fee of 100 basis points per annum.
5. To qualify as a market leader, the head portfolio manager needs to have at least 10 years’ experience managing small-cap portfolios.
Based on these objectives and requirements, the search will be pretty wide open. The Fund’s investment team has, however, made some very spe- cific requests with respect to manager tenure and product life. Using the in- formation on the Fund’s overall objective and the specific manager requirements, we can create a screen that fulfills our requirements.
Investment Manager Sourcing 19
ccc_travers_ch02_11-30.qxd 6/2/04 4:05 PM Page 19
Screening Criteria
Asset Class/Style Criteria
1. Include only U.S. equity products—this will eliminate all fixed income, cash, and other asset classes from consideration in this screen.
2. Include only small-cap equity products—this refines the screen by eliminating all products that are not small-cap.
3. Include only value style—this further refines the screen by excluding all nonvalue products.
At this point, the screen lists a universe of all U.S. small-cap value products. It is important to remember that a number of products that make it through the screen may not actually fit the small-cap value criteria because the data is provided by each investment manager. Because different people define “small cap” and “value” differently, the results will need to be more closely analyzed.
Performance Criteria
4. Include only products with track records greater than or equal to three years—per the stated requirements.
5. Include only products with three-year Sharpe ratios greater than or equal to 25th percentile within the total small-cap value universe; the 25th percentile represents the cutoff from the top 25% of the products in this universe (which is the top quartile) and the remaining 75% of the products.
Fee Criteria
6. Include only products with management fees less than or equal to 1%—per the requirements.
7. Include only products with no performance fees; while most (99%) of the traditional small-cap products do not charge any kind of perfor- mance fee, this restriction will eliminate the few that do.
Portfolio Criteria The restrictions state that the chosen manager must complement the Fund’s small-cap growth managers. This part of the search cannot be carried out at the screening stage. Instead, the Fund’s investment team will have to wait until the portfolio analytics stage to effectively con- sider this requirement. The word complementneeds to be defined further before any realistic assessment can be made and the results properly ana- lyzed. The analytical stage is covered in Chapters 4 through 12.
Manager’s Tenure Criteria Most third party databases include fields that list the portfolio manager’s and analyst’s tenure on the product they are
20 BEFORE THE ANALYSIS
ccc_travers_ch02_11-30.qxd 6/2/04 4:05 PM Page 20
currently managing. However, the restriction states that the lead portfolio manager needs to have a minimum of 10 years managing small-cap portfo- lios in general, not necessarily the portfolio he or she is managing cur- rently. We could screen based on tenure managing the current product, but it would likely eliminate most of the managers in this universe. It would be better to exclude this requirement at this stage of the search process. How- ever, it will be revisited when we receive the professionals’ biographies from the investment firms in the next stage of the process.
Product’s Status Criteria
8. Product is “open” for new investments, meaning that the investment management firm is still accepting assets. Experienced investment manager analysts may include “closed” products or run the screen a second time and review the list of closed products. I always look at closed products because there is a good chance that I know someone at that firm who might be able to fit in an allocation for me. In addition, database information is not updated on a real-time basis and, as a re- sult, sometimes the information contained in a database is stale—or just incorrect. Also, many managers reopen certain products for a vari- ety of reasons: (1) steep market decline decreases the product’s assets to the point where it can receive additional funds, (2) manager has change of mind and sets the maximum asset size higher, (3) manager recently lost some client assets. It doesn’t hurt to send a quick e-mail or make a phone call to verify that the product in question is still closed or to inquire if there are any plans to open it in the future.
9. Product assets are greater than or equal to $50 million—this is an arbi- trary number. Many organizations set the minimum asset size for a given product much higher than this. However, given the fact that small-cap products in general, and value-oriented small-cap products in particular, tend to close to new assets at lower levels than products in other asset classes, I thought it would be prudent to keep this num- ber on the low side.
Based on the various search criteria set, we have six main categories of screens that combine to make a total of nine different screening criteria.
After entering all nine factors into our database and running the screen, we are left with a list of investment managers that might be appropriate candi- dates for our search. Exhibit 2.3 depicts how the size of the manager uni- verse was impacted by each of the criteria we used in the screening process.
Exhibit 2.4 is a report that compares various characteristics of the managers that made it all the way through the initial screen.
This report gives us a good starting point for discussions about the
Investment Manager Sourcing 21
ccc_travers_ch02_11-30.qxd 6/2/04 4:05 PM Page 21
search and about the individual managers. But this is merely the first step in the sourcing process. Before we move on to the other methods of sourc- ing managers, let’s review a list of popular third party databases that exist in the marketplace today. This list represents databases that I have used at one time or another as well as other popular databases that I am aware of.
While the list contains many of the most popular databases currently in use, it is not all-inclusive.
Database Provider Web Site
Effron/PSN www.effron-psn.com
Checkfree Mobius www.checkfreeinvsvcs.com
Pertrac www.pertrac2000.com
InvestWorks www.investworks.com
Nelson Marketplace www.nelsoninformation.com Money Management Directory www.mmdaccess.com
Morningstar www.morningstar.com
Lipper Analytics www.lipperweb.com
Investor Force www.investorforce.com
Big Dough www.bigdough.com
22 BEFORE THE ANALYSIS
EXHIBIT 2.3 How Size of Manager Universe Is Impacted by Screening Criteria
Criteria Set #1: Style 1. U.S.
2. Small-cap 3. Value
Criteria Set #2: Performance 4. Track record > = 3 years 5. Sharpe > = top 25%
Criteria Set #3: Fees 6. Management fees < = 1%
7. No performance fee Criteria Set #4: Portfolio Portfolio characteristics cannot be done in the screening stage.
Criteria Set #5: Tenure Manager tenure > = 10 years Database insufficient to properly assess this.
Criteria Set #6: Status 8. Product open 9. Product assets > = $50M
15,000 Investment Products Reported to Database
Products Remaining
150
24
15
15
15
6 ccc_travers_ch02_11-30.qxd 6/2/04 4:05 PM Page 22
EXHIBIT 2.4Comparison of Manager Characteristics Firm/Product Data*Returns-Based Data* (Annualized) 3-Year5-Year InceptionFirmProductManager3-Year5-YearStandard Standard ManagerDateAssetsAssetsTenure†PerformancePerformanceDeviationDeviation CAM Asset Management1/1/98$410M$350M5.57.98.624.223.1 Zenith Capital1/1/93$13.6B$1.3B6.56.44.422.223.1 Revco Partners1/1/00$150M$150M3.57.2n/a24.7n/a Alders Asset Management3/1/97$1.2B$800M6.46.65.025.826.1 Eagle Capital Management2/1/00$210M$90M3.48.2n/a25.1n/a Cross Capital Management4/1/97$1B$400M6.37.97.525.123.6 S&P 600 SmallCap Index2.43.721.522.2 S&P 600 SmallCap Value Index8.03.823.321.2 *All data through June 2003. †Manager tenure is stated in years and represents period managing current product.
23
ccc_travers_ch02_11-30.qxd 6/2/04 4:05 PM Page 23