In choosing an investment adviser, use 'the 4 P's'

MUTUAL FUNDS

May 08, 1994|By WERNER RENBERG

When a major employer wants to engage an investment adviser to manage a portfolio of common stocks for an employee savings or retirement plan, it has hundreds of firms to choose from.

Its task is very much like the challenge that you face when you want to invest in equity mutual funds. You have hundreds of funds to choose from, including some that are managed by the same advisers.

Employers often turn to consulting firms to help them by identifying, evaluating and recommending advisers, and by monitoring them.

The biggest in this field, in terms of client portfolio assets ($500 billion) or advisers studied (1,400), is the Frank Russell Co. of Tacoma, Wash.

While you're familiar with some of its manager research clients -- AT&T and IBM, for example -- you may not know the Russell company, unless you have heard of it as the source of stock price indexes, which it has calculated since 1984.

Although its clients may have more dollars to invest than you do, their investment objectives -- long-term appreciation at above average rates without excessive risk -- may not be different from yours. It may be useful, therefore, to look to Russell's research to help in your search for managers who can help you to achieve your objectives.

Paul R. Greenwood, a senior research analyst whom you might think of as an equity management talent scout, says he screens advisers for what he calls "the four P's: people, process, portfolio, and performance."

You can apply these screens, too.

* People:

It is in screening the people who manage money that Greenwood has the biggest advantage over you. He interviews managers around the country and gets first-hand impressions of their experience and personalities, the strength of their motivation and the experience of the analysts they rely on.

You can't do the same. Therefore, unless you see a fund manager interviewed on TV, your impressions are likely to be based on what you read by them -- in reports to shareholders or in this newspaper and other periodicals.

Certainly you can draw some conclusions, such as whether a fund adviser uses a "star system" or a team approach. Greenwood finds that small groups can make decisions -- quickly seizing opportunities to buy or sell stocks -- while large groups can suffer from "analysis paralysis."

You may be able to learn when a manager has the additional incentive to excel by owning shares of the funds he manages -- something that's not required but would seem to be a vote of confidence in a fund.

* Process:

You can't ask managers personally to describe their processes of portfolio management, as Greenwood can, but you can read (( what they have to say in funds' literature or in magazine interviews about what leads them to buy or sell stocks and how they address risks inherent in their processes, such as being highly concentrated in a small number of securities.

You learn whether, in selecting stocks, they start out with an overall view of the economy, focus on the sectors that they believe are likely to be gaining strength, and seek the most attractive stocks in the sectors. This is known as the "top-down" approach.

Or you may learn they screen the stocks of as many as 5,000 corporations to find those that meet their criteria in terms of company size, rates of earnings or sales growth, price/earnings (p/e) or dividend/price ratios. It's the "bottom-up" approach.

More managers seem to use bottom-up than top-down. "I haven't seen a large number of top-down managers that have been consistently successful over time," Greenwood says. "They have make more decisions (i.e., choosing both sectors and stocks) to be right and may not have the resources for bottom-up confirmation."

And he adds: "Bottom-up managers are not operating in a vacuum. They know how the economy is doing."

* Portfolio:

By looking at a portfolio of the stocks in which a manager has invested, you can get an idea of whether the manager is sticking to his guidelines.

"The portfolio should be consistent with the process," he emphasizes.

If, for example, a manager says he invests in low p/e stocks, the portfolio should have a bias toward financial services and out-of-favor industrial stocks. "If you don't see them, something is amiss," he says.

* Performance:

Contrary to what you might think, performance is the last thing that Greenwood looks at -- although, of course, he will have used performance data in the first place to cull out the top advisers to whom he limits his research.

"The one thing you don't do," he advises, "is to pick a fund for performance alone. Performance should be a confirming tool. It should be consistent with the process and the portfolio."

He would compare a fund's performance with that of a benchmark for the type of securities in which the fund is invested, such as indexes of large growth stocks or small value stocks which Russell and others calculate.

"You don't get rid of a fund that underperforms the market," he says. "It may have underperformed for reasons that you shouldn't be concerned about. If you understand why a fund performs as it does, you may be able to have confidence in the manager."

Greenwood recommends comparing the performance of a fund with its benchmark over a period of years -- usually four to five -- to see how it behaved in different market conditions. He would assign less weight to data for a very long period because the adviser's process, the portfolio, and/or the manager may have changed during that time, rendering comparisons less meaningful.

If a manager can consistently outperform his benchmark while being 15 to 20 percent invested in cash, Greenwood is, of course, impressed. But, nonetheless, he is unenthusiastic about significant cash positions because they can hurt performance.

"You pay a fee for them to manage equities, not cash," he points out.

Baltimore Sun Articles
|
|
|
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.