The Trouble with Investment Management Consultants
I have been on both sides of the table in equity money management. I have hired and fired managers. Now I am looking to be hired as a manager, and I face something that distresses me — the consultants that advise potential clients. Personally, I think the consultants could do a lot better if they abandoned their overly simplistic model that categorizes managers on capitalization, value/core/growth, and domestic/international. It does not serve their clients well — I believe the most fundamental risk model in a globally connected world considers industry exposures, and ignores other variables.
Why? Industries tend to occupy specific areas of the “style box.” At one firm that I worked at, external consultants complained that our risk control procedures were nonstandard, because they were focused on industries and sub-industries. I counter-argued that our methods were better, because with a given industry, there was little variation in market capitalization and value/growth, but industry performance varied considerably. Though I am no longer with the firm, it continues to do well, while many that used the consultants’ model have died.
Look at it another way. Isn’t investng about finding attractive opportunities, regardless of how big they are, where they are located, or how quickly they grow? I think so, as does Buffett, Munger, Muhlenkamp, Heebner, Hodges, Rodriguez, Lynch, and many other successful fundamental investors.
Sometimes largecap names are attractive, sometimes smallcap. Sometimes deep value is attractive, sometimes growth at a reasonable price. Good managers analyze where the best value is, regardless of non-economic factors.
But if you have to cram me into the style box, fine, I am a midcap value manager that buys a few foreign stocks. But there is a huge loss in constraining intelligent investors through the style box. The better a manager is, the more one should ignore non-economic distinctions, and let him perform.
November 1st, 20087:41 am at
I do believe Russell does some consulting work on managers who are truly global managers and select securities regardless of where the company is HQD. I think this trend may grow. A challenge is that analysts and managers will have to understand the regional investor preferences, tax regimes, and currency issues, where a mid cap $US value manager will have an opportunity to have a comparative advantage through specialization.
November 1st, 20082:19 pm at
David,
Would you rather be the Queen in a game of chess, able to move any distance in any direction, or a style constrained pawn?
Seems simple enough to me.
Steve
November 2nd, 20088:23 am at
The “out of the box” managers are realizing right now why their methods are not sustainable in the midst of high volatility. Conventional approaches have lost many people a lot of money in the past six months.
November 3rd, 20081:18 am at
Steven Milos,
A question that arises when an institution hires more than one money manager is, how can they be sure that they aren’t buying the same sorts of investments? If two managers are both ‘queens’, that’s a possibility.
The other question, of course, is against what other managers should one manager’s track record be judged.
November 7th, 20084:01 pm at
Steve, Dave, I know why they do it. A bad queen is a huge risk vs. a bad pawn, and in the money management game, you win by hot being in the fourth quartile.
My problem is that industries are more fundamental than market cap, value/growth, or country.