Many active managers wrote to me directly after last week’s article (my 2^nd most popular ever), and I made many new friends along the way. Given that I am the CEO of Active Investment Management (AIM) Consulting, LLC, let’s keep with our active management theme.

Over the next two weeks I will be counting down to #1 my Top 10 Things That Hurt Active Management. As you will see, many of these things interrelate with one another, so ranking them properly is tough. Also, just below the items I have put in brackets who I think bears the responsibility for the issue. First up are my honorable mentions…

Honorable Mention #3: Poor Feedback Mechanisms

[research analysts, portfolio managers, directors of research, chief investment officers]

In my consulting work it surprises me how few active management firms have good feedback mechanisms. These are technologies of various kinds that provide insight into the quality of their decision making over time, and a sharing across the team(s) best practices for improving performance. To be coy, and to shamelessly urge you to work with me, there is one secret for doing this exceptionally well and that features huge in almost every consulting engagement I do.

Honorable Mention #2: Behavioral Biases

[research analysts, portfolio managers, directors of research, chief investment officers]

A hot topic for the last 10 years is how to rid or manage investment pros’ behavioral biases. You know what these are, right? Things like loss aversion, anchoring, herding, among many that are deleterious to quality decision-making. Lots of firms are investing resources in what they believe is a “last mile” effort. So, why aren’t behavioral biases ranked higher for me? Because every person has behavioral biases. Thus, it is likely that your competition has them, too. Consequently, not doing anything on this front is not going to hurt your performance much…for now. Ultimately, this will be a “last mile” issue, but we are not quite there, yet.

Honorable Mention #1: Conventionality

[research analysts, portfolio managers, directors of research, chief investment officers, distribution, the C-suite]

Most active investment managers just do not have a compelling reason to invest with them. They have “me-too” products and their “why invest with us” marketing docs say things like, “long-term investors,” “deep fundamental analysis,” “good relationship with management (at investments),” and “long tenured research team.” How many managers have studied the neuroscience of decision-making and know how to take advantage of it? How many investment managers have sophisticated, formalized idea generation based in science (do not quote to me, “screens,” that is sooo 1985), and how about formalized techniques for how to interview executive management?

I make my living as a consultant, not as a writer. My job is to help you and your investment team get better. So, contact me to learn how all of these insights can be integrated into what you do.

10. Impatience

[clients, advisers, investment consultants, asset owners, active managers]

Most of the detrimental impatience I see in our business is on the part of clients and their representatives. Yes, retail clients. Yes, retail clients’ advisers. Yes, investment consultants. And, yes, asset owners. These folks are well intentioned, saying things like, “we have a 3-5 year time horizon.” But, if they are honest, they don’t. They get antsy when performance lags for 18-24 months.

This hurts performance of active management as (I hope) we all know. The reason is that there is strong evidence that active managers can and do add value through security selection. That is, they know what they are doing. But, getting the timing right on an investment is very tough, and it takes time for performance to materialize sometimes. Have you ever seen those quotes about market timing that say things like, “had you missed the top 10 best performing days in market history then your performance is x% worse?” First, this is true (kinda, see my post that discusses this, toward the bottom), and it proves that clients and their reps need to be patient.

Rare, but still true, is that investment managers themselves are sometimes impatient. They abandon ship just as the storm is lifting. Or the firm loses patience with a high-quality investor because they are anxious that their clients are anxious.

9. Poor Sell Discipline

[research analysts, portfolio managers, directors of research, chief investment officers]

Admittedly, selling well is the hardest thing to do in investment management. No doubt. Worse, there are various schools of thought on this issue and so confusion abounds. One school says, “Let your winners run.” Great, tell me how long the race is, and I will let them run until then. Still another camp is all about target prices, fundamental value, and the like. While another camp is about arbitrary selling rules, including mechanisms like stop losses. This again features large in some of my consulting work. In particular, my sometimes partner on engagements, Michael Falk, has a totally unique approach here sure to be game changing.

8. Fear of Illiquidity

[portfolio managers, directors of research, chief investment officers, traders, asset management boards]

It once took me 42 days to get a trade filled for a position. So, I get it: liquidity be real. Yet, if you have done an incredible job in your due-diligence (see the claims made in Honorable Mention #1), then it is likely that you have a good grasp of possible risks. Also remember, most active investment managers are long-term investors. Therefore, a great firm (as decided by you) is worth risking the illiquidity penalty. Also, an important point…you hearin’ me? Illiquidity can benefit you to the upside. If your great prospect is suddenly the stock du jour then excess demand on limited supply = big pop. Folks forget this.

7. Uncompetitive Prospectuses

[chief investment officers, C-suite, asset management boards]

Given the “me-too” nature of active investment management, and the increased access to data, the march of passive strategies and ETFs, and unhelpful monetary policy, please tell me that you review your prospectus every once in awhile to evaluate its competitiveness. Huh? What is that? That is the contract between you and the client. Yeah, I know that, but…But nothing. If your competition has a more flexible charter and they are attracting assets and you are not, yes, it is usually because of performance. But what if that performance is enhanced because the prospectus is in alignment with the qualities of the research staff and it unshackles them to do their best? What if your prospectus says we will hold a name that violates our cap strategy for only 30 days, and your competitor’s docs say they can hold for up to a year? Chances are their winners can run…run long. Touchdown!

6. Inability to Recognize Talent

[portfolio managers, chief investment officers, human resources, recruiters]

It is my belief that most asset managers do not know how to identify high quality talent. Instead they use as a proxy the school that someone went to. Or their GPA. Or their major. Or their pedigree, as in the firm they are leaving. Or personal relationships. And so on. Guess what? That is exactly what everyone does. Do what everyone does, perform like everyone does. Questions for you from this consultant: do you have a list of the actual skills needed to be exceptional at investment management? If so, do you have ways of measuring these things a priori? Do you have interviewing techniques that allow you to get truthful representations about candidates’ talents in their answers rather than rehearsed ones? Do you know how to measure their idea generation prowess? Their intuition?

Next week I will conclude with the Top 5 Things That Hurt Active Management. Be there, or be square.

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