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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Similarly, institutional investors such as pension funds draw on outside advice, primarily in the form of investment management firmsFollowing the piper sharing responsibility investment consultants Few individual investors have the time, skills, or technology to assess the value of large publicly traded corporations and other assets. Yet all are obliged to make far-reaching personal investment decisions. As a consequence, many rely on outside counsel to try and avoid costly mistakes and improve the performance of their portfolios. They seek help from a variety of brokers, financial advisers, mutual fund managers, and the like. Similarly, institutional investors such as pension funds draw on outside advice, primarily in the form of investment management firms. But in addition, the executives of these funds increasingly make use of another level of counsel: how to select the managers of their money. The need for objective information about investment managerstheir people, products, processes, performance, and principleshas led to the development of the institutional investment consulting industry. Today, institutional consulting involves much more than picking good managers. The better consultants are expert on all aspects of large fund management, including asset allocation, governance, asset class strategy, and structure. Investment Consultants Guru: George Russell Some individuals in this book started companies. Some started investment styles. But few started industries. George Russell started the institutional investment consulting industry. Pension funds began entering the equity markets in the United States during the 1960s. Following World War II, most institutions invested only in bonds to reinvest the income and protect assets in the event that the widely expected depression put the funds in danger. When confidence began to return in the 1950s and 1960s, pension funds began to look to equities for return. But their experience was limited to bonds from the previous thirty years. George Russell saw the need for investment counsel on the research and selection of investment managers, expected demand to be huge, and met it. Using his grandfathers small mutual fund distribution company in Tacoma, Washington, as a base, he went to the largest pension funds in the United Statesby definition, those most in need. He brought market information gleaned from his marketing visits packaged as research and applied it to extensive work at each fund. He had a keen sense of quality, was comfortable in the corporate setting, and gave conviction to the newly responsible corporate officials who hired him. And the Russell organization, coming from what was then an improbable northwestern base, grew in stature and importance. With Russell providing sales guidance, the high-level contact work, and a research organization that had the first manager database, he became a necessity for pension funds and later endowment funds. Russell could speed dial almost anyone. He could even enter the money management field in competition with the money managers on whose performance he advised Russell consulting clients. Indeed, he formed a large and very successful investment management business based on the multiasset class, multistyle, multimanager strategy he used with his consulting clients. The firms growth charged forward as Russell initiated a major international effort, with non-U.S. firms wanting to emulate the returns in the United States. Other consultants went into the business. Some offered more personalized services but none grew to the same scale as the Russell organization under George Russells leadership. Every project he undertook was pursued with zeal. When raising money for a glass museum, he had a list of targets everywhere in the world. No one was safe from his aim. When he supervised the building of a large boat for himself and his wife Jane, he carried the plans with him everywhere. They would often come out between meetings and be penciled on with improvements to the builder. Mountain climbing memorabilia abound in his office. You can tell he likes to attack and win the summit. In the early 1990s, George Russell founded Russell 20:20, a group composed of twenty money managers and twenty institutional investors interested in studying opportunities in the emerging market world. The representatives in these groups were generally chief executives or chief investment officers. Highlevel group visits would be planned each year to some promising command economy undergoing economic transition. The stated purpose of studying investment possibilities was a desirable one during the emerging market boom of the early to mid-1990s. But other functions took place as well. Despite admonitions not to engage in selling, you could not put a group of twenty vendors and twenty high-level buyers together without selling taking place, albeit with subtlety. And George Russell would deny he was one of the aggressive violators of the group norm: I am not going to push this outstanding private placement on you although there is only one place left. The combination of a high energy level, a keen sense of needs and how to meet them, and an ability to be personal with a large number of important people produced someone who could start an industry. And someone who has wide interests in public service and support of the arts. Counterpoint Conflicts of interest and business experience are often two sides of the same issue. Consultants are challenged to defend how they can preserve confidence when they consult for clients in competitive markets. They also enter into competition with money managers whom they may have as customers for services, including strategy services. And some consultants are paid in soft dollarsa dubious but common practice of leaving an excess of transactions fees in commissions for easy payments for research, consulting, and a wide range of other items that otherwise would be hard dollarsdirectly on the agents account or dollars deposited directly into the funds account, effectively reducing brokerage costs. This compensation practice is accepted as an accommodation to almost every part of the investment business but, by its inherent nature, it is a violation of the quest for lowest execution costs. At the same time, by being in the middle of these questionable practices, consultants do get to expand their information base. In this way, they become more useful to clients, although perhaps they do so after their own needs have been met. Increasingly, consultants have tried to shift their business from hourly fees for services to products like funds. The Russell organization has been most aggressive in competing in the consulting arena and with managed funds. And the managed funds often use the same managers as the consulting arm recommends, but at a lower fee than is accepted by the manager for clients without such influence. (The rationale for a lower fee charged to a consultant-based fund is that there is no marketing expense.) However it may be, consultants are in the middle of almost everything that happens. The consulting firms are accused of failing to use their information for better decision recommendations to clients. Instead, the consultants may be hired to support decisions made by the clients staff people. The consultant might just be needed to give credibility, especially to bodies like pension committees of boards of directors, where the staff people need more cover. Charles Ellis (our guru for Investment Policy) writes: Investment consultantsI call them selection advisershave made a great difference in one dimension of the business and no difference at all in another. They have made a difference in terms of increasing the speed at which some investment managers accumulate or lose assets [under management]. They have had a large influence on the redistribution of assets from larger organizations to smaller ones. They have not made a difference in terms of adding value for the clients. They are not able to prove that they choose better money managers. Theyve gotten a lot of investors to pay attention to more data, but I think they have a pretty short time horizon. Ellis adds: Theres a wonderful sign in Vail, Colorado, that all investors and clients of investors should contemplate. Its near the childrens ski slope. It says: Leave your kids for the day$15. You watch$20. You help$30. The same sound interest in benign neglect should apply to investment management. The use of investment consultants by institutional investors outside the United States has been growing significantly in recent years. As many parts of the world have tried to recreate the financial structure developed in the United States, it is thought that a quick and easy way of doing this is to hire a consultant. Marketing advice, performance measurement, and general corporate strategy have all been popular areas for which non-U.S. managers hire consultants. The products these customers expect to receive are the techniques developed by U.S. managers serviced by the consultant. Consultants can provide a useful service, often if pushed to go beyond mere support for ideas already grasped. But they do so at large cost and at the risk to investment managers, who share information with them, of reducing the time a proprietary investment function may be profitable for its inventor. Guru Response George Russell comments: It is tough to make broad generalizations about consultants. Like investment managers, they should be analyzed individually, giving credit and blame where due. Some add much more value than others. Russell has actually measured the performance of our buy-ranked managers, and our ranks have added value. The clients who have followed our advice have shared in that outperformance; Russells own funds certainly have. But why do some clients not benefit from the value of our buy list? Manager research is only one element of the success. Effective implementation is equally important, and this sometimes gets neglected. Our experience has taught us that effective and timely decision making, along with an emphasis on portfolio construction, is critical to capturing added value in a multimanager context. Plan sponsors often do not have the skills and resources required to implement as effectively as a manager of managers. We currently advise clients with total assets in excess of $1 trillion and can document the value added in relationships that now exceed twenty-five years. With less than a 2 percent turnover in our client list, their long-range evaluation of the value added speaks for us. The firm, since its original goal of forty U.S. large pension consulting clients was met in 1974, has grown at an annual compound growth rate of 24 percent per year since thenminor evidence of the markets opinion of at least one consultant. The consulting business has evolved since its beginnings and things will continue to change. Our view is that going forward, companies and foundations must either build expertise internally to oversee effectively asset class strategy, implementation, and manager selection; or hire someone who can do it for them. We believe more funds will outsource the investment management function to fund-of-fund providers who do this as a core business. Where Next? Investment firms have a choice on how to guide their activities. They can strive to be first in some or several fields. In this case, they may be first and foolish, but they will gain a pioneering reputation for themselves and often win high rewards for clients. Or they can decide to be best. This usually means copying others, improving on their methods, taking small incremental steps to be better, and marketing intensively. Both approaches are suitable to the institutional marketplace. The selection of one or the other is often due to personality, but each requires vastly different resources. But how should institutions select their investment managers? Essentially, there are three kinds of managers. The firstthe easiest to recognizeare the mediocre and arrogant ones, the ones most likely to damage you. Fortunately, there are few of these since the really bad ones are deselected quite quickly, and business takes them out of the universe. Picking the bottom 20 percent to ignoreassuming 20 percent of managers have a skill set one standard deviation below the meanis rather easy. Most investment people can recognize the qualities to avoid in almost any profession. The middle is where it is toughest to discriminate: Everyone looks alike under their marketing blankets and the differences will be minor. But it is the top groupthe 20 percent of managers one standard deviation above the meanthat you want to look at most carefully. Investment consultants advise looking for the three Ps: people, performance, and process. Of course, people count and minds count: The investment business is a thinking one. Performance measurement too seems necessary because managers rarely get hired if they are in the bottom half of the performance spectrum. And process or housekeeping is obviously important. But today it is a given with the off-the-shelf tools common to most institutional managers. Armed with these three Ps, search teams form and make decisions, usually with disappointing results. Half the managers with durable past records stumble, people come and go, process gets tighter (usually to the benchmark), and time flies. Every manager will be retained until their results are poor, and they are absolutely sure to be in that position sometime. Can you look at managers and say you want them when their results are bad? Whats missing to improve the winner ratio? Two more Ps, taking the number up to five, the last of which is the most important of all and the least considered: Product must be examined: What is it and do you want it? Can you un derstand it? Most importantly, is it an asset class that will gain in usefulness and popularity? Is it sound and is it adaptable? Product tends to be forgotten except to define the niches to be filled in an asset array. But product means more than a niche or a benchmark. It means the rationale behind it: How is it adaptive and what will it become? Investment is not static and the changes are more important than the positions. And the last is principles: What are the managers fundamental guides intellectual challenge, money, selflessness or selfishness, ego, collegiality? In the clutch, when the manager has to move on instinctand this will happen at critical positionswhat will the manager do? This question depends on judgment that it is not possible to make based on facts. In naval leadership training, officers are taught that any decision that comes to the captain will not be made on facts; otherwise, it would already have been made at lower levels. So the captains job is to make the decision on the basis of principles and to be decisive. So in selecting an investment manager, examine the principles. If you find they do not exist, flee. If you find they do exist but you do not like them, walk away slowly. But if you find them consistent with your belief system, and if enough of the other Ps are present to satisfy you, stop searching: You are home. |
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