As Seen on TV, Fund Holdings Come & Go; People Are Paramount
What do your favorite TV shows have to do with evaluating funds and money managers? Stay tuned to find out. In 2024 alone, the LPL Investment Manager Research (IMR) team had over 600 meetings with investment decision-makers for mutual funds, separately managed accounts (SMAs), and active exchange-traded funds (ETFs). Of course, we ask many questions about the holdings in their funds or accounts. This may include what they like about the company, the research used in the buy decision, and how it fits their process and portfolio. We also ask questions that glean insights about the people who impact the portfolio and how they interact to make decisions.
When you invest in a fund or SMA, in addition to accessing its current holdings, you access the expertise of its portfolio manager or investment team. In theory, if a fund’s annual portfolio turnover is 50%, after one year’s time, half of its current holdings will be gone from the fund. What remains intact are the skills, abilities, and resources of the investment team.
Who’s the Boss?
A fund’s official portfolio manager (PM) is listed in its prospectus, a legal document that describes the fund’s objectives, risks, fees, and investment strategy. A fund may list a single person or multiple PMs. Here’s where it gets interesting. In many cases, more people impact the fund than just its PM(s). PMs may also vary in the ways they participate in the investment decisions. Sometimes, despite one PM listed in the prospectus, we understand from our discussions with the fund company that a committee vets potential fund holdings in a collaborative way. In other instances, several PMs may be listed, yet it is one particular PM acting as the lead PM. Lead PMs may vary in their openness to ideas and feedback from other members of the investment team. So “Who’s the Boss,” and why does it matter? When evaluating a fund, we want to understand whether today’s key decision-makers are the ones responsible for its past performance. When a PM leaves a fund, our knowledge of the investment team helps us assess whether the departure may weaken the fund’s decision-making. It might be akin to that TV show that was never quite the same after it lost one of its main characters.
The Deep
Depth of resources is a key consideration when we evaluate funds and SMAs. We seek to understand how many people contribute ideas to the portfolio, in what ways they do so, and how they communicate with one another. In addition, we want to know who would take over if one of the key decision-makers left. Some investment teams have staggering resources. This may include a large staff of PMs and analysts located around the globe, 24/7 trading capabilities, proprietary data sets, or a robust network of contacts among industries, academia, or policymakers. While some of those resources are likely to exist at larger firms, smaller firms may have their own unique advantages that foster depth of expertise. Smaller firms may be simpler organizations, with less “red tape” and distractions, allowing greater focus on a particular niche rather than catering to many different investment styles. These “boutique” firms may develop a deeper understanding of a smaller number of companies in their portfolio. Regardless of a firm’s size, we seek to understand how it cultivates its people and resources to generate a competitive edge.
Next Level Chef
PMs of a fund or SMA function like chefs. They take ingredients (stock or bond research) from other people (analysts) and blend them together (portfolio construction), striving to create a satisfying outcome. Let us (or lettuce, if you like) break down the facets of this analogy. First, most PMs — even if they are solely listed in the prospectus — do not go it alone. They often consider ideas pitched by analysts or use an analyst’s research to inform their opinions. As such, PMs are only as good as the ingredients they have. Additionally, an investment portfolio is more than a collection of stocks, but ideally, a carefully considered blend of holdings that fit well among the other holdings and owned in appropriate weightings. Nutmeg may be the perfect spice for a dish, but too much could ruin the entire meal, just as owning too much of a risky stock could damage an entire portfolio.
Finally, a famous TV chef is adamant that nothing leaves the kitchen without being tasted. Likewise, we prefer when PMs “eat their own cooking” by investing their personal assets in the funds they manage. This may better align their interests with the interests of fund shareholders. In fact, academic research1and our in-house research suggest that funds with high levels of PM ownership are associated with better performance. Of course, past performance is no guarantee of future results.
Closing Thoughts
As one of the largest financial firms, LPL has extensive meetings with investment teams and key leaders at asset management firms. In these meetings, we ask questions that help us assess the merits of the investment team. The “people” considerations are just one of the “6 Ps” of our evaluation process for mutual funds, SMAs, and actively-managed ETFs. The other “Ps” are Parent (company), Process, Portfolio, Price, and Performance. Stay tuned for future “spinoffs” where other elements of our evaluation process may be discussed.
1Khorana, Ajay, Henri Servaes, and Lei Wedge. 2007. “Portfolio Manager Ownership and Fund Performance.” Journal of Financial Economics: 85 (179-204).
Important Disclosures
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Asset allocation does not ensure a profit or protect against a loss.
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Indexes are unmanaged and cannot be invested into directly. Index performance is not indicative of the performance of any investment and does not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.
This material was prepared by LPL Financial, LLC. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
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