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A Full-Time Professional Shares the 4Ps of Fund Selection July 13, 2012
We spoke with Claudia Roering, Head of Fund Selection, Deutsche Asset Management to learn from the professionals about fund selection, and how she identifies outperforming funds.
Author : Nick Tay


A Full-Time Professional Shares The 4Ps Of Fund Selection
Key Points
  • Claudia Roering, Head of Fund Selection, Deutsche Asset Management says fund selection is about creating alpha by selecting the best funds and managers that deliver excess returns over a complete business cycle
  • The 4Ps of fund selection are: Products, Performance, People, and Process
  • Products are about eligibility based on certain investment criteria, the cost of running the fund, the fund’s size
  • Performance focuses on the track record of the fund, and how the performance varies across a full market cycle
  • People looks at the structure of the fund, and how stable the team is
  • Process looks at the approach of the fund manager, and the step-by-step evaluation of how the fund makes investment decisions
Imagine scanning through more than 140,000 funds on your computer screen and you have to choose one fund to occupy a position in a portfolio. Repeat that process till satisfied with the portfolio. In a nutshell, that’s the job of Claudia Roering, Head of Fund Selection, Deutsche Asset Management.
Choice is good, but when you have to choose from thousands, there’s a very real chance of paralysis from analysis. So how does Claudia deal with all the data to select potential outperformers?

Selecting Fund Managers
“Fund selection is about creating alpha by selecting the best funds within a certain category, and managers that deliver excess returns over a complete business cycle,” says Claudia.

Some technicalities bear explaining: Alpha is a measure of risk-adjusted return, and in simple terms, expresses how much value a fund manager adds (or subtracts) from a fund’s return. A complete business cycle includes up and down markets, and Claudia is quick to note, “In the past, business cycles were 7 years long, but in recent times, we’ll need to get used to shorter business cycles going into the future.”

Claudia joined Deutsche Asset Management in July 2007, and she has 18 years of experience in traditional and alternative asset classes. In breaking down the fund manager selection criteria, she distilled the evaluation into 4Ps, “There are a couple of criteria for evaluation purposes, the 4Ps, which are Product, Performance, People and Process,” says Claudia.


Source: Deutsche Asset Management (DWS Investments)

The 4Ps of Fund Manager Selection: Products
Claudia drew the example of DWS Premier Select Trust, where she is the fund manager behind the fund, “The first constraint is eligibility. We operate this fund in Singapore, and it’s a CPFIS-included fund, so this defines the eligibility of underlying potential funds.”
Fund size is another factor when evaluating products, “we don’t want to invest in extremely small funds, and end up the largest holders of illiquid strategies. We also don’t like funds that have received tremendous inflows, and have grown beyond capacity, and end up being the last to enter before performance deteriorates, which usually does.” Acceptable fund size varies with the strategy of the fund. For instance, a large cap strategy can comfortably manage several billion dollars in Assets under Management (AUM), while a small cap strategy will likely have problems finding opportunities for growth with billion-dollar assets.

“Cost is the next factor”, continues Claudia, “and in some cases, too little time on issues like portfolio construction and efficient implementation because this is where a lot of fees potentially go to waste if you go through high transaction costs or high bid-offer spreads. So it’s important for us. Negotiating in fee agreements, institutional share classes, is definitely very important to us.” When pressed to elaborate, Claudia replies coolly, “It depends on the strategy. I’d be willing to accept a higher fee for an emerging markets debt fund than a developed bond fund. So it depends on the alpha potential of the asset class.”

The 4Ps of Fund Manager Selection: Performance
Performance is one of those things that can distract investors into making hasty short-term decisions, like sinking funds into an unknown manager with little track record.

And track record is one of the things Claudia looks for in managers, albeit not necessarily with the same fund. “Usually we look for a manager with a track record of three years, but that’s not set in stone. Say the manager has just set up a fund boutique or has just changed jobs and we trust they will continue the strategy as done before then we are comfortable with that,” she says.

For Claudia, choosing a manager is a long-term investment. “In terms of performance, if we select an asset manager, we’re in for the long term. We don’t go through all the due diligence and kick him out after a few months of poor performance, unless something severe happens, in which case we could and would. But overall the intention is to invest in the manager for a prolonged period of time after we have a thorough understanding.”

Of course, the disclaimer that past performance doesn’t guarantee future performance holds true, and according to Claudia, “in the end it’s not about historical performance, we need to believe the manager can perform in the future once we invest in their fund. Performance can look good on paper, but could be just achieved by coincidence. There are always some outliers on the very good and very bad side, but not necessarily achieved systematically.”

The 4Ps of Fund Manager Selection: People
The management of key-man risk is an issue all fund managers have to grapple with. Some do it better than others, and part of Claudia’s job is to identify teams that can function, even if they’re down one (or two) members. “We look at people – who is in charge? Is it a key man approach centered around some genius or does it revolve around a team, which is the approach we prefer as an institutional investor with more fiduciary focus. If someone goes on holiday, or if something just happens, or some personal troubles happen, fund performance could change, hence we prefer a team process.”

Other factors include the stability of the organization, and how the team works together to generate its competitive edge over other fund managers.

The 4Ps of Fund Manager Selection: Process
The final P is their process, which hones in on the investment process of the fund manager.

“We want to understand how the manager will perform in various market environments, and that comes down very much to the investment process, which is something we focus most of our analysis on. This is really the core of our qualitative due diligence,” says Claudia.

Among the tools she employs are due diligence questionnaires (DDQs), and requests for proposals (RFPs) but on top of these tools is a comprehensive series of interviews, which she conducts with members of the team onsite.

“We always meet the manager in person, and not just the product manager but the portfolio manager in person, and/or an analyst. We try to meet more than one person, just to get a full description of how they really live the process. We really ask them questions until we are happy with the results, and we usually make sure we meet them onsite in their offices,” says Claudia, who further notes these meetings are often in place to establish not just the investment capabilities of the fund, but also the operations and compliance capabilities of the fund managers, as Claudia elaborates, ”They can’t just have the investment side in place, they must also have operational procedures, risk procedures, compliance, adequate trading rules, etc, and of course, in case of an emergency, they should have some sort of backup plan. So it’s really a thorough process not just to pick out the last basis point of excess return, but a reliable group of superior performers. If you have such a robust selection process, it’s inevitable you will leave out some very qualified managers, but it is more importantly, it filters out the bad ones, which is the intention behind such a rigorous process.”

And that’s pretty much how the full time professionals, who invest in funds full-time, pick funds. We wrapped up our interview with a few examples of the 4Ps at work.

Assembling The Final P – Portfolio
While Claudia and her team carries out the 4Ps (Products, Performance, People, Process) to create a shortlist of quality funds, asset allocations decisions are made by the multi-asset team in Deutsche Asset Management, and this forms the basis for their asset allocation to various asset classes, such as stocks, bonds and alternatives.

To illustrate how the interplay between asset allocation and fund selection works, Claudia gives an example of the rationale behind an investment decision, “We used to have a DWS Real Estate Fund in the portfolio focusing on Asia Pacific real estate, with quite significant exposure to China. That was a tactical asset allocation decision and the decision had performed quite well in the past but then we saw the Chinese market under pressure and we expected the correction in the property market to last much longer.  Even though the fund was fine with regard to performance versus the benchmark, we decided to redeem it completely because we were quite concerned with the development of the specific sector.”

So on the issue of outlook, how is Claudia positioning the portfolio for the remainder of 2012?

“It’s extremely difficult to make a long term forecast at the moment because markets are not driven by fundamentals so much, but rather by policymakers. And we’re really at the mercy of policymakers and whether they can come up with a viable solution at the end of the month at the EU summit. If they can come up with a solution that is convincing to the markets, then it would be a major step forward. The markets will be very different if the muddling through continues, and I think the pressure will depend on the developments in various countries. Not so much Greece, because everyone is familiar with the potential Grexit so that’s not much of an issue, the concern is greater in Spain, with short-term yields around 5%, and this will exert pressure and drive markets,” says Claudia.

Given this outlook, and the DWS Premier Select Trust’s 5.86% holdings in SPDR Gold Trust as at 31 May 2012, the question I posed to her was whether she thinks gold is a good hedge against volatility – an asset many investors often flock to in times of extreme uncertainty. After a 5 second pause, Claudia replies, “That’s a difficult question, because I don’t think gold is a valid asset class in its own right. It has received significant cash inflow, and gold prices are only partly driven by fundamentals. With regard to investor interest and market volatility, the correlation is unstable. Gold is too unstable for it to be a good hedge against equity market volatility. However, if you want a good asset to hold in times of extreme crisis, then yes gold is useful. I would say gold is a much better hedge against inflation.”

Sometimes taking a professional view of things is certainly something all investors can learn from.

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