An investor’s philosophy is the intellectual framework they use to generate alpha; their process is simply how they execute on that framework.
By Clare Flynn Levy, CEO, Essentia Analytics
“I’m afraid of messing with my process. It might make me worse.”
This is one of the most common objections we hear at Essentia. And having been a portfolio manager for many years myself, I totally understand it. If you’ve got a process that has worked in the past – and, moreover, if you’ve communicated that process to your investors as a reason they should invest with you – changing it feels like very risky business.
The fear of future regret (aka the fear of looking like an idiot later) is a very real part of the life of a professional investor.
But ask any asset allocator which is less troubling: a portfolio manager who presents a well-thought-out and evidence-based process change before a failure takes place, or one who makes a hasty change — after the failure has occurred?
Timing aside, “well-thought-out” and “evidence-based” are the important terms here. Let’s assume that any process change the investor in question makes is not made on a whim. It is made deliberately, by that investor (rather than by someone else), and informed by the most thorough and reliable statistical research available today. Is the risk of this change really on the downside? And if performance then hits a bad patch (which could easily happen, regardless of the process in place), is the allocator going to be more likely to pull their money? I’ll let the allocators among you opine.
For all the talk about the importance of following your process, it turns out that the thing that the world’s best fund managers hold onto the most tightly is not their process at all. It’s their philosophy. An investor’s philosophy is the intellectual framework they use to generate alpha; their process is simply how they execute on that framework.
Nicholas Simar, a senior portfolio manager at NN Investment Partners, made this point well in a recent discussion we had. With Essentia’s help, he has made small changes to the process behind his European High Dividend strategy, all the while staying true to his value philosophy. The result has been 180bps of incremental outperformance, per annum, for his investors.
As he told me, ”You need to keep your philosophy and you need to remain true to that style. But at the same time, you need to accept that you need to use new tools that were not available 20 years ago.”
The reality is that your investment process will change. It must change. The world is changing, the available tools are changing, the market is changing, and your competition is changing. As a fund manager, you have one choice: change with it, or get ready to change into a person who is no longer employed as a fund manager.
Clare Flynn Levy is CEO & founder of Essentia Analytics. Prior to setting up Essentia, she spent 10 years as a fund manager, in both active equity (running over $1bn of pension funds for Deutsche Asset Management), and hedge (as founder and CIO of Avocet Capital Management, a specialist tech fund manager).
