Investment Managers Face Heightened Scrutiny

As more wealth managers and multi-family offices outsource their investment decisions to third party asset managers, these assets managers are coming under greater scrutiny—and not just for their investment performance.

Wealth advisors say they are stepping up their efforts to know more about the investment managers they hire beyond their track records. Many are insisting on on-site visits, and closely monitor not only personnel changes in an investment shop—but the personal lives of the firms’ principles as well.

“This is a people business, and when you hire an outside investment manager, you’re hiring a collection of people,” said Chris Battifarano, portfolio strategist for GenSpring Family Offices, which outsources all buying and selling of securities. “We never hire managers without seeing them and we require site visits for all managers we use.”

Asset managers visiting GenSpring are in “salesman mode,” he explained. But going to their office allows wealth managers to “see things you wouldn’t see otherwise. For example, you see how people interact, where they sit, if it’s an open floor or if offices are isolation. One is not better than the other, but what you see should comport with what they told you. And if they said analysts and portfolio managers work closely together but they are on opposite sides of the room, that’s not good.”

Organizational stability is also critical, wealth managers say, and high turnover may be a red flag. Seeing how investment managers use and treat their team is “the most important thing to review,” according to Nathan Dudley, managing director, investment services, for Threshold Group. “Everything revolves around people, and the quality of the investment professionals you’re working with is pretty much paramount.”

Investment managers should have “a committed core of decision-makers who have been there for a long time have some sort of equity participation,” according to Rick Pitcairn, chief investment officer of his family’s Jenkintown, Pa.-based multi-family office. By contrast, they shouldn’t have “a lot of turnover in the operations department.”

Not surprisingly, the principals of investment firms receive heightened scrutiny. “We look at the firm, the managers and the portfolio,” said Steve Prostano, chief executive of Silver Bridge Advisors. “We want to be aware of anything that varies from the norm. It can include personal issues, like a manager who is going through a divorce. That wouldn’t be a reason to fire someone, of course, but it may affect their performance and they might be put on watch.”

Personal Lives Not Out of Bounds

One wealth management executive who asked not to be identified said he always made a point to go out to dinner and have drinks with the firms’ investment managers. After a few glasses of wine, one investment manager began showing pictures of himself with his arm around a woman the executive knew was not his wife, a lapse in judgment that ended the managers’ relationship with the firm.

Such intense oversight is expected to continue as outsourcing increases, along with pressure for maximum due diligence in a post-Madoff era.

According to a study released last week by the Family Wealth Alliance, family offices are increasingly “off-loading responsibility for their investments to external CIO firms,” spurred by complexity, market turmoil, regulatory fears and the difficulty and high cost of hiring CIOs internally.

The chief investment officer function will continue to be outsourced because firms no longer have the capacity to properly oversee complex investments such as alternatives, industry guru Jamie McLaughlin said in a presentation at the New York Society of Security Analysts earlier this month.

Less Capacity

Gary Carrai, senior managing director for wealth management platform provider Fortigent, maintained that the outsourcing trend is being driven by wealth managers’ drive for growth. “There is a clear shift to grow faster,” Carrai said. “As a result, wealth managers are looking for ways to immediately broaden their offering to capture more prospects while leveraging their time in getting there. Outsourcing all or components of the investment offering is a natural byproduct of those growth goals.”

The Bernard Madoff scandal has insured that wealth managers aren’t taking their eye off the ball, Carrai added. “Risk management and liability have moved up the importance curve with wealth managers in this post-Madoff world,” he said. “The depth and consistency of a due diligence process has greater value now than it did three years ago.”

As for performance, wealth managers say that it is rarely the main reason for firing an asset manager.

Role of Performance

“Firing a manager is probably the hardest decision we have to make, and while everything is on a case-by-case basis, it’s rarely based on performance alone,” said Bartholomew Earley, director of investment research for Manchester Capital Management. “It’s usually as a result of bad or unethical decisions the manager has made.”

“If we fire a manager based on performance, it means we missed something along the way,” said GenSpring’s Battifarano. “Perhaps it was a change in personnel or process. Or assets under management got to a level where the strategy could no longer be effectively managed.”

Favorable personal attributes can help predict performance results, Pitcairn maintained. “We want to identify producers of future alpha and risk-adjusted returns,” he said. “Doing that by a quantitative process is approaching it backward. We want to get to know the managers really well and we think those qualitative factors will lead to quantitative results.”