Managing Investment Firms

a review of maximizing potential

Agenda
Expert opinion input from industry leaders
Management philosophy and culture Management Fundamentals Special situations

A framework for managing alpha teams Conclusions

Organizational culture
Gary Brinson Brinson Partners
Guiding principles : the equations
Philosophy + People + Process = Performance Performance = Investment results + Client service Maximum performance = Maximum business results Teamwork is the collegial interaction and collaborative activity that form a common bond for achievement Execution supersedes intention Quality in everything we do preempts quantity The pursuit of excellence must be pervasive and unrelenting There are no higher ethical values than truth, honesty and professionalism Commitment, dedication and hard work are our instruments of success Enjoying ourselves and maintaining a pleasant working environment are important elements of success Individual rewards are tied to performance meritocracy We will always benefit from critical review and a goal of constant improvement

Guiding principles : the beliefs

Organizational culture
Gary Brinson Brinson Partners
Observations
Success comes to those who increase their worth. To increase your worth, you have to do more than gain new knowledge and skills. You have to become the kind of person with whom others like to work The greatest ability is dependability Enthusiasm makes ordinary people extraordinary

Critically Appraising Management Truths

David Fisher Capital Group Companies
Never forget : this is a people business
Any number of approaches can work but each is dependent on talented people The key to success is the attraction, motivation and retention of talented people There are no right answers it depends on the people The most efficient answer to an organizational issue is often not the most effective Investment success is about anticipating change Where companies are located is becoming decreasingly important Investment organizations have to act locally and think globally Be careful of profit centers within the organization Do not over-manage the effort Having fun is important

Elements of Organizational Success

Success is defined in terms of the team rather than individual needs and aspirations

Managing Investment Companies

Alison Winter Northern Trust Bank of California James Rothenburg Capital Research and Management Company
Seven components of success
An effective leader with a clear vision of
Where the firm is going What is necessary to get there The ability to effectively communicate that vision across the entire organization

A clearly articulated investment discipline An appropriate business strategy and the structure to support it The right investment talent Objective incentives that pay employees well and help retain them A clear understanding of the culture of the organization and how to maintain that culture The technology necessary to enable the staff to perform their jobs well

Emphasis of team over individual Channel competition externally not internally Compensate staff in line with client objectives

Leading Investment Professionals

Claude Rosenburg RCM Capital Management
Managerial stance
Empathy and humility mistakes are inevitable Understanding why decisions were made is as important as the decision itself Be prepared Set priorities Ask impertinent questions Analyze the analyses of others Investment discipline every holding should have a purpose Communications discipline recommendations need to be unambiguous Objectivity - do not get too close to a company Challenge staff to be creative and come to conclusions in innovative ways

Work habits of successful analysts

Discipline

Creativity

Job Satisfaction among Investment Professionals

Russell Reynolds Surveys
Factors influencing job satisfaction
Most influential Work itself / Day-to-day responsibility Sense of professional achievement Taking responsibility Relationship with supervisor Balance between work and personal life Outlook for advancement Compensation Relationship with colleagues 87% 80% 80% 70% 68% 68% 66% 60% 78% 86% 77% 40% 35% 52% 54% 40%

2004

1996

Least influential Work conditions

Policies on HR / operational matters Job title / Status

25%
21% 18%

23%
9% 33%

A Framework for Managing Alpha Teams

An investment paradox
If managers can truly add alpha to a pre-defined benchmark, then any constraints can only add inefficiency Fund objectives are far more efficiently achieved through maximizing tracking error in your alpha component and adjusting a beta component to target overall tracking error Yet we always target overall tracking errors through constraining alpha managers!! IR = / Stdev(i) IR = IC * B * TC : f(Skill, Breadth & Transfer coefficient) = Volatility * IC * Score : f(Volatility, Skill & Expectations) Factors are not independent e.g. Skill and transfer coefficient both decrease with breadth Alphas deteriorate with tracking error Skill deteriorates with volatility that is inversely related to expectations certainty Alphas and information ratios are subject to significant change

Practical considerations

It is thus practically expedient to constrain alpha managers

A Framework for Managing Alpha Teams

Optimal approach is to give managers maximum freedom within set parameters
Manager autonomy Tracking error

Turnover

Fund & Benchmark

Style / Size bias # of stocks / concentration

Every mandate requires

Explicit benchmark Set parameters Agreed targets (Alpha, information ratio, horizon)

The Importance of Benchmarking

Criteria of good benchmarks
Unambiguous (securities and weights clearly identifiable) Investable (can be fully replicated) Timeous (specified in advance) Accurate (correct representation of objective) Sustainable (information required for build available in forseeable future) Universe Opportunity set Beta or default position If the performance yardstick is the competition, the benchmark should represent them If the performance yardstick is the non-investable (e.g. CPI), the benchmark must reflect the neutral policy that achieves the goal over time

Benchmarks give us insight into

Benchmarks are the standards by which success is measured

Benchmarks provide enormous insight into the competitive investment landscape

Delineating responsibilities for Alpha Teams

Management provides support
Infrastructure including
Real-time comparison of fund vs benchmark Structure Performance Attribution Compliance Scenario analysis Decision support tools Database Analytical tools Research and recommendation representation

Environment Execution Decision review Adherence to mandate and parameters Results Agreed time frame (synchronized to client service needs)

Teams implement decisions

Client service requires input from both sides

Systems are key

Conclusions
Jim Ware describes managing investment firms like trying to herd cats
Investment professionals are independent, skeptical, curious, resistant to authority and generally intelligent Managing these individuals is best achieved through a respectful partnership

Success is a combination of talent & environment, infrastructure and interaction Teams are more consistently successful than individuals It is better to have a good performer that lives the firms values than a star who doesnt By definition, successful Alpha investment firms are required to deliver alpha
Fund managers and analysts are paid to make and effect decisions that deliver results Management is required to provide the environment that maximizes potential results These two roles are not interchangeable but are interdependent Failure of either will generate sub-optimal results and must be addressed

Success is defined in terms of the team not individuals Performance = Investments results + client service

Regulatory Information

Peregrine iQ (Pty) Ltd Physical Address: 6th Floor, Letterstedt House Newlands on Main Newlands 7700 Telephone number: 021 670 4900 Internet website: www.pq.co.za Peregrine iQ (Pty) Ltd is an authorised financial services provider (license no. 608) approved by the Registrar of Financial Services Providers (www.fsb.co.za) to provide intermediary services and advice in terms of the Financial Advisors and Intermediary services Act 37 of 2002. Market fluctuations and changes in rates of exchange or taxation may have an effect on the value, price or income of investments. Since the performance of financial markets fluctuate, an investor may not get back the full amount invested. Past performance is not necessarily a guide to future investment performance. All returns are rand returns, unless otherwise stated. Investment deals done on behalf of clients by Peregrine iQ are all done on an arms length basis.