How I Evaluate Investment Managers

This post will probably be too brief, but here goes.  The most important aspect of analysis is trying to gauge any sort of sustainable competitive advantage.  Qualitatively, do they really have something special going that other are unlikely to imitate?  Second, do they fit their paradigm?  If they are growth investors, do they use momentum?  If they are value investors, are they willing to be wrong for a while?

Third, how do they handle lesser questions like earnings quality?  Do they look at cash flow, free cash flow or earnings, and how do they justify their answers?  Do they have a decent decisionmaking process, given that managers that trade less tend to do better?

Finally, have they been successful?  Do they win, and do they win for the reasons that their methods would favor? Good track records that emerge for reasons other than managerial intentions are unlikely to be repeated.

Now what don’t I look at?  Sharpe ratios and other quantitative measures of risk.  The measures aren’t predictive of future performance, and the risk adjustment is too short term in nature.  These measures are backward looking, and not indicative of future performance.  Better to spend time sweating over how a manager chooses assets, limits risks, etc., than to focus on quantititive measures of risk that have no relation to long term performance.