How to screen for a money manager

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Like building a sturdy foundation for a home, selecting the right money manager for a family office can pay enormous long-term dividends for investors willing to take the time to conduct due diligence to secure the right fit.

“If you’re a family office, there are a lot of people vying for your attention,” says Dan Riverso, chief investment officer at Jesselton Capital Management Inc. in Toronto.

“People think it can be quite easy to choose a manager, but I’ve seen it time and time again where people are quick to choose managers. They don’t fully understand the manager as they fail to follow a process, and then they encounter an issue in one way or another,” says Riverso.

Many technical and personal hurdles need to be cleared before making a decision.

Leanne Scott, a vice-president and portfolio manager with Leith Wheeler Investment Counsel Ltd. in Vancouver, says it is very important for family offices to hire managers with technical qualifications and standards that have been bestowed upon them by the CFA Institute.

“Charter holders have to adhere to professional codes and ethical standards that are regulated by the CFA Institute, and there is also a strong focus on continued professional learning,” she says.

Riverso notes that in order to conduct a full search, a database of managers needs to evaluated and a process established to narrow down the list. That is a time-consuming process.

“A quantitative way of narrowing down this list would be by using a performance screen. Such a screen could incorporate a number of metrics, including absolute and/or relative performance factors, versus a benchmark or against peers, in addition to risk-adjusted performance metrics,” he says.

After narrowing down that list to a reasonable number, family office representatives should have an initial meeting with those managers. Investors should also conduct operational meetings, where an operational person describes the account opening process in detail, and ideally they should also interview a compliance person to acquire more in-depth operational knowledge, Riverso suggests.

Undertaking background checks and reference checks that are both investment and operationally driven can also provide valuable insight on a manager, he adds.

Peter Mann, president and co-chief executive officer at Grayhawk Investment Strategies Inc. (Grayhawk Wealth) in Toronto, stresses the importance of independence. He says that a money manager is only providing independent advice on a financial instrument or product if he or she is not receiving any kind of financial remuneration for recommending that instrument or product.

“If the manager and investment are comingled, the investment is not independent. It doesn’t mean it’s not good. It just means that it needs to be caveated by the fact that there is a lack of independence. You expose yourself in times of challenge to risks that are out of your control,” says Mann.

Prospective money managers also need to be asked directly whether they receive a fee from any of the financial instruments or products they are recommending the family office invest in. The family office needs to determine whether, for example, they are paid a trailer fee on transactions and, if so, how much they are paid.

“These are very pointed and direct questions that a lot of people don’t know how to ask or they think that they’re not allowed to ask,” Mann explains.

The client’s own level of expertise is also an important element of this exercise. If the client does not have the ability to interpret and evaluate the prospective manager’s returns to determine how they have performed in the past, and predict how they will perform relative to any future agreement regarding performance parameters with the family office, this may create difficulties involving objectivity.

“I would argue there are very few people that have the capability to be able to do that on their own, which means you then become very reliant on the manager to tell you how they’re doing, which is a real challenge for most people because it’s rare for a manager to expose their own errors. They are more apt to move the goal posts,” says Mann.

Mann suggests asking for a reference from a client that has recently signed on with the prospective manager, a long-term client that has been with the manager for at least five years, and a client who has recently left the manager.

“Those would be three people that you’d typically want to be able to meet and speak to. You’ll get the goods about the money manager, including the challenges and the positives,” he says.

In order to have a good personal fit, “you have to like the person. But more important, they have to be a good communicator, straightforward, honest, possess high integrity, and be ethical,” says Scott.

“They also have to be willing to discuss difficult or uncomfortable topics with you. They can’t shy away from the hard conversations. Clear and honest communication is always the best way to go,” she stresses.

“One thing that bothers me is sometimes people aren’t honest and straightforward with a lot of things, particularly fees. Fees should be 100 per cent transparent and fair. There should never be any hidden fees,” Scott adds.

It is important to have a good relationship with the manager and to be in contact with them to understand what they are doing and know they are forthcoming with information, says Riverso. “Ultimately they’re going to make a mistake, and when they do, if they’re not forthcoming and they’re not honest about it, and you find out about it through another channel, you lose trust,” he warns.

“Most investment managers are solid people. They abide by all the rules and the regulations and everything else. They enjoy managing money. They want to do what’s best for their clients. But there are bad apples out there. On top of that, when a mistake happens, [being] human, sometimes they might not be as forthcoming with information as you would want,” Riverso elaborates.

The ultimate goal of due diligence is for investors to gain a high degree of comfort with the manager who will be assuming stewardship of their capital.

“Through a due diligence process, you should get to know the team and how they approach investing, but also set reasonable expectations for future performance which you can track as you monitor the relationship over time. Try to avoid the trap of simply focusing on historical performance, which is akin to investing by looking in the rear-view mirror,” Riverso advises.

Mann says that evaluating the performance of a money manager over a six-month to one-year time frame is too random and insignificant, and requires a longer period to be effective.

“I think realistically at year three there needs to be a conversation if things aren’t going your way – and then in year five if they still haven’t gone your way, it makes perfect sense that you’ll want to do something different,” he suggests.