The Future of Investment Manager Due Diligence (and a Look Back at Q1 Performance)

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When you want something you have never had you will have to do something you have never done.  Anonymous.


Despite the continuing global financial crisis, the uprisings in the Middle East and the Japanese disaster, global stock markets delivered positive results in the first quarter of 2011. These upheavals tested the mettle of investment managers, so you need the proper perspective to evaluate investment performance. The question, “Is performance good?” requires an answer to yet another question: “Relative to what?” As usual, some styles, sectors and countries performed better than others in this first quarter. Have your managers seized upon the better segments and/or selected exceptional securities? Where have they succeeded and failed?

Bottom line: Have they earned their fees?

Of course, one quarter is too short a timeframe to get excited about winners and losers, but we should get excited about the emerging importance of real due diligence, which is about to become a fiduciary obligation.  In October of 2010, the Department of Labor issued a recommendation to remove a 35-year old fiduciary exclusion for advisors who select investment managers. If adopted, many advisors who prefer to not be held to a fiduciary status will have a decision to make: stop providing manager recommendations or get serious about manager research.

Those who accept this responsibility will want to tighten up their due diligence processes.  They will need to conduct manager research like it’s never been done before. When they do, they will discover something they’ve never had before, namely good active management performance versus passive alternatives. Clients can get what they deserve.

In the second part of this commentary you’ll discover what due diligence procedures need to change and why. If you don’t have time for real due diligence when will you find the time to explain your mistakes?

Insights into the first quarter of 2011

Style Returns for Q1/2011

US markets in the first quarter of 2011 delivered three consecutive positive monthly returns, although March was a squeaker, eking out a modest 0.2% gain. As the chart on the above shows, every US style posted a positive return for the first quarter of 2011, continuing the recovery that began in March of 2009. This quarter’s 6.2% market return brings the 25-month return from March 2009 to March 2011 to a whopping 100%. Consequently we’ve turned the corner in recovering from 2008 losses; the 39-month return for January 2008 through March 2011 is a positive 1.4% un-annualized, or about 0.4% per year. It’s taken all the running we can do to stay in the same place.