The business of selecting fund houses & fund managers

To put things in proper perspective, selecting fund houses & fund managers is a second-order problem statement for investors. The first-order problem statement, which has far more significant impact on returns, is the decision on how much to allocate between asset classes. Ultimately, what matters is the percentage of your savings allocated to stocks (equity) versus bonds (debt).

Which fund house or fund manager you choose matters far less, as it has a significantly lesser impact on your portfolio’s return. The asset allocation decision carries vastly greater weight. In fact, to truly drive home this point, we would state that selecting a fund house & fund manager is a tenth-order problem statement, with asset allocation occupying the first nine spots!

Against this backdrop, it is unfortunate, though not unexpected, that the second-order problem statement receives far more attention. But that is the reality of the market. The saner voices attempting to restore balance, like in most areas of life, are outshined and outshouted by the louder, more visible ones. It is therefore up to the consumer (the investor, in this case) to make saner choices and spend their time, money, and energy accordingly.

At Serenity, we spend inordinate time on solving for the 1st order problem - building models and frameworks to help our clients solve for their asset allocation decision. Given our organization structure (single line of business and single source of revenue), this comes naturally to us and helps us steer clear of the excessive noise around the 2nd order problem.

Having stated the above, we do spend the necessary time (what we feel is necessary) in selecting the fund houses and fund managers we allocate our clients' funds to. We do all the necessary due diligence - both on objective & subjective factors.

However, we have complete clarity that we do not have any magic wand or special ability to identify the best fund managers, who will stay the ‘best’. Based on past track record, it is easy to identify the ‘best’. Artificial Intelligence, if prompted properly, can also provide that data. However, whether they will stay the ’best’ requires Superman-esque capabilities, which we do not have. Hence, you will never find us making any claims to this effect. As a matter of fact, to stand apart from the long list of claimants out there who claim to possess such capabilities, we actively dispel such expectations.

We follow a few simple rules:

First & foremost, we are clear that we are not in the business of fund management. We see that as a conflict of interest. If we must do justice to the business of selecting fund houses & fund managers, we cannot be in the business of fund management.

Second – we have a clear bias towards large pedigreed Institutions which have been around for a very long-time and which have stood the test of times. We’d like to allocate a significant part of our clients’ portfolio to such Institutions.

Third – outside of the above, we are always on the prowl to look for those ‘special talent pools’, which usually sit inside boutiques, who either wish to stay boutique OR even if they wish to grow, they will much rather excel in their chosen area of expertise. We like teams which are focused and which, while wanting to grow their business & bottom-line, will stick to their core competency & ideology. We find their apparent ‘cockiness’ (stubbornness to stick to their core) as a strength. That we have only one source of revenue (advisory fee we earn from our clients) frees us from the usual constraint’s the rest might find themselves in. Please also refer to Note no 1.

We usually avoid the middle of the pack – who we believe are neither-here-nor-there, who are neither ‘boutique’ in their thinking & execution nor an Institution (in the true sense) yet, who are spinning out schemes after schemes, products after products to capture the latest fancies. Culturally we find this cohort at odds with ours.

Fourth – once allocated, we let the fund houses/fund managers do their jobs. Mutual funds are our preferred vehicle (given the huge tax advantages they enjoy over other vehicles), and we are fine with just letting them be. We are mindful that any changes might affect compounding (due to taxes). There must be a very compelling reason to change. This is truer for the funds we allocate to the pedigreed Institutions. We are not part of the circus that goes on in the advisory industry, of constantly chopping & changing the mix. Often, it is mere activity that does not move the needle and leads to (totally avoidable) transaction costs & taxes. And hence lower returns and importantly lower returns on ‘your’ time invested. Please also refer to Note no. 2 & 3.

Last but not the least - we maintain equal levels of openness & cynicism in our selection process. No one is above scrutiny (including the pedigreed fund houses / revered fund managers) or below contempt (the neither-here-nor-there folks).

Two, amongst the several fund houses we are engaged with, follow a policy of not paying out any commissions. Both have built an enviable good track record in their area of expertise and logically deserve a deeper engagement and due diligence. However, majority of their AUM is built on their efforts and word of mouth. Only a fraction has come from advisory firms. The bottleneck being their policy of not paying commissions. This however is not a bottleneck for us. It does not matter to us as we have only source of revenue - the fee our clients pay us. For those who do pay commissions, the commission element gets rolled back to our clients in the form of a lower fund management fee. It also does not matter to us if the fund sits inside a competing wealth management firm. We have no insecurity in introducing such funds to our clients. Very recently, for a specific product (where the talent pool available in the fund management industry is limited), we are engaged with a wealth management firm which has built a good track record in this product.

Sharing the link to a recent interview given by Warren Buffet, Chairman and former CEO of Berkshire Hathaway. He was asked how he is dealing with the changes in the leadership teams of the companies he has invested in – likes of Apple & Coke. While the entire interview is worth listening to, listen in to his answer to this specific question between 14 & 17 minutes.

Re the circus – we keep reminding ourselves that we are advisors helping our clients take wise asset-allocation decisions (the 1st order problem, going down to the 9th order) and then allocate their funds to a few funds (the 10th order problem). We are not the ones doing the hard miles it takes to manage a fund, picking stocks or bonds, picking the right sectors, etc. We have our place in the sun and so do these fund managers & fund houses. When we recommend them, while we do our best possible to make reasonable choices, we do not end up owning them or their performance. If they do well over the long term, we can take a little credit and vice-versa. But we do not own them. Our two professions are very different. We are two sides of the same coin.