A (Former) Insider’s Guide to Choosing an Investment Manager

Managing your own investments is hard, time-consuming work, so many people choose to delegate the task to a professional investment manager.

Some do this via mutual funds, while others have a separately-managed portfolio. In either case, the challenge is that choosing a good investment manager can be as confusing – and as risky – as picking your own investments.

Having spent over two decades in the investment management business, I have some experience with this issue. Based on that background, I’d like to offer some tips on choosing an investment manager or investment products like mutual funds.

First, though, an important clarification – I am no longer in the investment management business. I am a full-time financial writer and analyst who is not paid to represent any investment firm or products. So, take the following advice for what it’s worth, but be assured that it’s fully objective.

The following are five key considerations when choosing an investment manager:

Decide on active vs. indexing

This is a big debate within the investment community. Do you want an investment manager to have broad discretion for choosing investments, or do you want a portfolio that closely mimics a specific index, like the S&P 500?

There is a great deal of support for indexing, because it reduces individual mistakes by an investment manager, and it tends to be much cheaper. However, there are so many indices these days, each representing a narrow market segment, that it can be difficult to choose the “right” mix of market segments to make up the overall portfolio.

Given the above, one way to decide between active management and indexing is to choose the approach best suited to the role you want to play in structuring your portfolio. If you want to retain the responsibility of finely tuning a specific mix of asset classes in the portfolio, then you will want to choose your own mix of indexed products.

On the other hand, if you want to broadly delegate investment responsibility, then you might want an active manager with wide discretion. The tips that follow are focused on choosing active managers, because the performance of those managers can make more of a difference, for better or worse.

Look for reasonable fees

In comparing active managers, you aren’t necessarily looking for the cheapest fee. After all, you wouldn’t choose a surgeon based on who had the lowest bid. At the same time, fees should not be so expensive that they take a big chunk out of your investment returns.

Look for fees that are around the middle of the pack among investment managers you are considering – these should be no more than one percent for equity funds, and less than half that for bond funds.

Focus on market cycle performance

From September of 2002 to October of 2007, the S&P 500 rose by 90 percent. Then, from October of 2007 to February of 2009, it lost more than half its value. If you had looked at investment records during that first period, the most aggressive managers would have looked best – but these would probably have been clobbered the most in the subsequent downturn.

During that falling period, the most conservative managers would have looked best, but they would have been likely to lag behind when the market started to recover. The point is, to get a full picture of an investment manager’s track record, you need to look at both rising and falling periods.

In other words, base your judgements of track records on a full market cycle, rather than on arbitrary three- or five-year periods that may be dominated by a bull or bear market.

Consider the assets under management

When looking at a product’s market cycle performance, look at how much money was under management throughout that cycle. You’ll want to know whether this track record includes the bulk of the money the manager had in that style during the period, to determine whether it is really representative.

Also, if you see a huge jump in assets under management in recent years, be a little cautious — you certainly want a manager that is attracting rather than losing assets, but an exponential increase in money under management can interfere with how an investment approach is implemented.

Beware of conflicts

Generally speaking, paying an investment advisor a fee based on a percentage of your portfolio aligns both of your interests — the more your portfolio grows, the more money your advisor makes. What you want to avoid are situations where that advisor’s interests aren’t aligned with your own.

I’m talking here about instance in which the advisor earne commissions for representing particular products, or commissions based on the amount of activity in your portfolio. If you’re not sure, make a point of asking.

Nothing can guarantee that you will pick winning investments, but keeping these tips in mind will help you avoid some of the most common mistakes that cost people money.