The Elusive Search for Alpha: Natural Enthusiasm

I have written recently about the importance of having a clear process in place for the evaluation, selection and monitoring of active investment managers. A well-defined process can help sidestep serial underperformers and shortlist managers actually worth considering. For those managers that make the cut, you then want to find the ones who have a genuine passion for what they do.   

Given the percentage of active managers that fail to consistently outperform their benchmark, the universe of active managers for consideration, across any asset class, narrows very quickly. After shortlisting a pool of managers that have delivered reasonable performance on a risk-adjusted basis, the next stage of the analysis is to appraise the underlying performance, including things like:

• How was the excess return delivered?
• Did the manager take major bets to generate return?
• How are ideas generated and how are they executed?
• Did the manager continue to invest according to their mandate?

The purpose being that you get a sense of how the manager achieved the outperformance and most importantly whether it is repeatable. If you are comfortable with how the performance has been delivered and with the process behind the strategy, you would then need to look at the growth of assets under management and the resources behind the manager. Some of the questions would include:

• How has the fund size grown and has it grown too quickly?
• Has good performance as a small fund been followed by a spike in inflows?
• How have the resources of the team grown with fund AUM?
• What is the capacity and is there a process in place for managing inflows to the fund?

If the assets under management (AUM) have grown too quickly, as investors have chased performance, the manager may not be positioned to invest the larger pool of capital. It could simply be the case that the AUM may have grown too large for that particular strategy to be implemented successfully. For example, a fund investing in small cap stocks could end up being force to own large concentrated positions if the fund grew too large.

The objective of the shortlist process is to find managers with an investment process that is intuitive, implementable and repeatable, backed by the resources of a strong organisation, with the compliance and risk management procedures that will ensure the assets remain secure.

However, a systematic process for analysing managers can only get you so far; it tells you a lot about the past but the real challenge is picking the winners that will deliver over the next ten years. Therefore, in the case of single manager active funds, some qualitative judgment on the individual in charge will be a deciding factor in the final stages of any fund selection process.

Ultimately, in making the decision to choose an active manager over simply investing in the low cost passive alternative, an investor is expressing a belief in that manager to outperform. Belief being the key word, since nobody has a crystal ball. For me, the qualitative factor that I value most is the passion they show for investing; the best managers live and breathe it.

Again, I must bring it back to a football context, because we can see how passion and enthusiasm separates the elite managers from the good ones. The legendary Bill Shankly, Liverpool manager 1959-1974, called it “natural enthusiasm” (see video), a cornerstone of his success and something that has endeared him to the Liverpool faithful long after his passing. “It’s the greatest thing in world…if a manager is honest, and he has this natural enthusiasm, whilst he can’t go on the pitch with the players he can convey it to his players, he is with them and they are with him, and they’ll be successful”.

Now if you are reading this from your office, in front of your computer, you might say, ‘Vincent, what are you on about? That is football, this is work, the real world’. The relevance is that football is a means to illustrate the spectrum of people which exists in all walks of life. The best people in every field view their occupation as more than just work. That natural enthusiasm for what they do spreads through an organisation and the inevitable results follow.

Shankly once said of his star number 7, “half the world is short of natural enthusiasm, but Kevin Keegan isn’t, and that plus his ability makes him a player”. The same applies to the investment world. If I was a trustee taking the risk to invest in an active manager over the low cost passive alternative, then I would want to be convinced of their passion for what they do, that it not just for the money. Otherwise, it is not worth the additional time, effort and costs involved in selecting an active manager.

Concluding on a football note, it is clear that new Liverpool manager Jürgen Klopp possesses an unrivalled enthusiasm for his job, something that is inspiring belief in players and fans. Mat Hummels, Klopp’s captain at Borussia Dortmund, said of ‘the normal one’: “he lives, breathes and thinks football, day after day”. As it happens, those managers in the investment world that have that same passion are just as rare as they are in the football world. But they do exist.