In a world where unprecedented events seem to be happening with regular occurrence, it is more important than ever to find stewards of capital with the talent, temperament and expertise to navigate through such uncertain times. This is no easy task and recent studies have reminded us that past performance in isolation is not a sufficient guide. Here at Momentum, we believe the key lies in thorough due diligence backed by an experienced and independent research team.
The latest in the long line of unprecedented events this year has been the release of US GDP figures which revealed an annualised -32.9% decline during the second quarter. While annualising the period from April to June is somewhat misleading given the highly unusual circumstances, it is nonetheless a startling figure which was certainly not in anyone’s forecasts at the start of the year.
When looking to allocate capital during periods of economic crisis, it is natural to look for managers who have been through tough periods before and have come through them with flying colours. This process is complicated by several factors. Firstly, the average US fund has a life of less than nine years and so probably would not have been around during the last great crisis. Secondly, even if the same structure is still going, the original portfolio managers may have moved on, creating uncertainty around how much knowledge has been retained within the business. Thirdly, there is always a question as to how similar the current crisis is to any preceding ones (and finding an investor with experience of the last global pandemic in 1918 would be challenging to say the least...).
On top of this, a recent study by James Choi of Yale School of Management has shown that over the period between 1994-2018, funds with historically strong returns have statistically failed to outperform poorly performing funds over the subsequent 10 years1. This raises questions over the utility of using past performance data as a guide to the future.
Given all of the above, selecting the best managers from a global universe of funds requires a particular level of care. At Momentum we have developed a mixture of quantitative and qualitative tools to help us in this respect, and we spend a lot of time talking with investment managers to fully understand their philosophy, process and areas of expertise. Our longevity and pedigree in working this way also gives us the advantage of tracking how funds, investors and management companies develop over time, providing us with greater conviction in our conclusions.
One important factor to analyse is an organisation’s culture. While a lot of this is intangible, much flows from the business structure and the overall incentivisation framework for the team. Investment teams with long term incentives and a vested interest in the business are likely to be more aligned with investors, particularly during tough times. Another key area is understanding the specifics of particular manager styles. This gives more context to past performance, and helps us to better understand the causes rather than simply relying on it as a forward predictor of returns.
Our approach has not only helped us identify the top talent in investing ahead of their peak, but also provides the structure for us to build diversified portfolios with complementary performance drivers. Our blend of funds with contrasting styles and philosophies provides resilience through different economic environments, which is especially helpful when uncertainty remains high.
Lorenzo La Posta
The first half of the year was like a Spaghetti Western. Amid a global pandemic, some industries thrive (the Good), others go through a rough patch (the Bad), while economies and societies strive to recover (the Ugly). Let’s hope there’s no sequel to this tragic period.