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How to evaluate and select an asset manager

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With the mainstreaming of portfolio management services (PMS) and alternative investment funds (AIFs), investors are spoilt for choice. Currently, there are over 365 portfolio managers and 900 AIFs registered with market regulator Sebi, and this number is increasing at an exponential rate. Asset managers generally tend to rely on parameters that have traditionally been used for evaluating investments in mutual funds: past performance, comparison of returns relative to the benchmark or peer group funds over different time and horizons, and risk-adjusted returns. This approach is not adequate, as portfolio managers under the PMS or AIF platform have greater latitude in managing money and run unfettered portfolios with flexible pricing options.

The portfolio manager selection process could be made more comprehensive by incorporating a few parameters that have been used by foreign institutional investors (FIIs) when they evaluate investments in different asset classes, target geographies and investment strategies across global markets. As a portfolio manager for some of the largest sovereign funds in the world, these are some of the learnings from the team of Karma Capital.

Asset manager and asset gatherers: An asset manager will maintain a limited number of funds with no other related or unrelated businesses, thereby ensuring a significant amount of time is committed to managing the funds and other linked activities. An asset manager will launch a PMS or AIF in a manner that is open only for a limited period or with clear guidance on the optimal or maximum size of assets under management. This approach ensures that it remains manageable for the asset manager without impacting the risk and returns of the investors.

Some asset gatherers, however, try to maximize the fee income by launching several funds that are open perpetually, compensating employees on the basis of new investors or assets they bring in, cross-selling or upselling related services. Many large overseas university endowment funds in the US have invested in India almost exclusively through boutique PMS firms—choosing them over large better-known sponsored entities.

Long-term approach: It is generally accepted that portfolio managers with a long track record have witnessed troughs in performance, in absolute terms and in relative terms compared to the benchmark or peer group. Instead of placing maximum emphasis on the volatility of the portfolio’s outcome, the FIIs evaluate if the portfolio manager believes in overarching investment philosophy, has remained steadfast to the approach, demonstrated discipline with the process and has the ability to maintain a dispassionate view of the investments, irrespective of short-term price movements.

Alignment of interest: An employee-owned portfolio management firm or a significant amount of co-investment of personal capital by the portfolio managers ensures a strong alignment of economic interest. There are other areas of alignment of interest as well. For instance, certain investors avoid ‘sin’ stocks or are attracted to an ESG-aware investment style, while others seek a specific investment style. A sudden change, by either the investor or the portfolio manager, will neither be practical or ideal for both parties for building long-term wealth.

Reliance on Investment Advisors: Though FIIs have some of the best or largest internal investments and research teams, many still rely on external investment advisors to identify suitable portfolio managers. They understand that an investment advisor will be able to give them an unbiased view of several portfolio managers, identify their competitive advantages, and carry out certain aspects of the due diligence on their behalf in a way that portfolio outcomes can be maximized. In fact, almost all of the largest private and public pension funds have advisory firms helping them in their own investment processes.

Yogesh Thakkar is co-head, business development, at Karma Capital

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