To ask or not to ask – 10 Questions to ask your Investment Providers

To ask or not to ask – 10 Questions to ask your Investment Providers

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To ask or not to ask – 10 Questions to ask your Investment Providers

MERCER AUSTRALIA

You’re new to the Board of a charitable trust. The Fund has a sizeable investment portfolio and investment matters take up a decent chunk of Board time. The trouble is, you don’t know much about investments – and you’re not the only one. One or two other Board members seem to know what they’re talking about, but the rest of you remain resolutely silent.

 

There’s a Board meeting next week and a fund manager is coming along to talk about the investment strategy they manage on your behalf. You are aware that ensuring your manager is doing the job they have been asked to do is a key part of your fiduciary duty, but you feel ill-equipped to do this. 

Fear not, here are 10 questions[1] you can ask about your investments – in no particular order. Most are directed at your fund manager and/or investment consultant, but there are one or two you can ask your fellow fiduciaries. Starting with these questions will make you more engaged, more informed and get the ball rolling when those awkward silences occur at question time.
 

1. WHAT’S KEEPING YOU AWAKE RIGHT NOW?

QUESTION FOR YOUR FUND MANAGER / INVESTMENT CONSULTANT

Let’s start somewhere easy. “What’s keeping you awake right now?” is a simple way of inviting your investment provider to share their view of current conditions, with a focus on areas of concern. 

The response should help you understand more about the current investment environment and importantly, whether or not your provider can articulate how it could affect their strategy. 

And like any good question, the answer should open the door to follow-on questions. The provider that responds with “nothing” is missing the point. A world without risk is a world without return. The provider that responds with one or two areas of concern can then be asked, “What are you doing to manage, mitigate or take advantage of those risks?”.

A more effective variation of ‘what’s keeping you awake?’ could be: “What’s the worst that could happen?”.

This is not so much about the current risks, but more the fundamental risks inherent in any investment strategy. A follow-up question to this line of enquiry can focus on not only what is being done to mitigate or manage the risk, but also whether or not you expect to be fully rewarded for the risk.
 

2. HOW DO I EXPLAIN THIS INVESTMENT TO OUR STAKEHOLDERS?

QUESTION FOR YOUR FUND MANAGER / INVESTMENT CONSULTANT

Your investment consultant is proposing the Board considers adding a new investment strategy to the mix. It sounds convincing, but it includes a lot of jargon, such as alpha and beta, idiosyncratic risk, hedge funds and long/short. The trouble is that you don’t really understand how the strategy actually works.

You’re aware that one of the Board’s investment beliefs is that it should only invest in strategies it understands. Rather than putting your hand up and saying, “I don’t really understand how this works”, there’s another approach: 

Ask the consultant: “How do I explain this investment to our stakeholders?”.

This should provide you with a plain English explanation of the strategy and is a good way to work out whether they really understand it themselves. You need to master a topic in order to explain it in simple terms.

Hopefully this will allow you to follow up with other questions. Of course, you already know one that would be great to ask at this time: “What’s the worst that could happen?”.

3. WHAT DO YOU KNOW THAT MILLIONS OF OTHER INVESTORS DON’T?

QUESTION FOR YOUR FUND MANAGER / INVESTMENT CONSULTANT

A fund manager is pitching their investment strategy to you. It sounds brilliant, their track record looks impressive and they seem really switched on. The presentation has a suitable array of colourful charts, tables and diagrams. Everything points to this being a good idea.

However, you wouldn’t expect a fund manager to point out all the weak points of a strategy.

Your Board’s investment beliefs include the principle that markets are not always efficient and that some active managers can exploit those inefficiencies. To help you assess your fund manager’s proposition in the light of this, you could ask: “What do you know that millions of other investors don’t?”.

This should help them cut to the chase. If you think about the global nature of investing, the extent to which information is readily available and the sheer number of investors, it can be useful to adopt the view that it’s not easy to beat the market. The fund manager must be able to convince you that they have identified some aspect of the market that is inefficient – and that they can turn it into an extra return for your beneficiaries[2].
 

4. WHAT HAVE YOU GOT WRONG – AND WHAT DID YOU DO ABOUT IT?

QUESTION FOR YOUR FUND MANAGER / INVESTMENT CONSULTANT

It’s hard to get it right all the time. In fact, if you did it probably means there’s no risk. And if there’s no risk, there’s unlikely to be any return. This assumption suggests that things will go wrong. The good news is that learning is an important part of improvement, and our own mistakes can provide the best lessons of all.

Asking “What have you got wrong – and what did you do about it?” could help you learn some important things about a provider.

First, there’s a difference between confidence and hubris. No one wants a manager who is blind to their own weaknesses. For example, if their initial decision to buy a stock turns out to be wrong, do they have a mechanism to recognise and correct the position? Wrong calls are inevitable, but this does not mean the situation should be stubbornly maintained.

Secondly, as markets evolve, aspects of an investment strategy that worked in the past may no longer be appropriate. We don’t want managers that change their spots every time the wind alters direction, but nor are we interested in those whose strategies do not evolve. 

Another way to discover whether your manager has the right mind-set might be by asking,“Things don’t always go according to plan: what do you do when that happens?”.

5. HOW MUCH OF YOUR MONEY IS INVESTED ALONGSIDE OURS?

QUESTION FOR YOUR FUND MANAGER

There are multiple criteria for selecting the right fund manager or investment consultant. Being a great manager that provides excess returns is, of itself, unlikely to be enough. You want one whose interests are well-aligned with yours. For example, this might include having a similar time horizon and sharing a concern about how much of the return is lost to fees and costs.

Asking “How much of your money is invested alongside ours?” is one way of testing manager alignment. Some managers are restricted from investing in anything other than their own strategies, helping ensure that any great investment ideas are not kept to themselves, but shared with clients. 
 

6. SHOULD WE BE DOING THIS?

QUESTION FOR YOUR BOARD / INVESTMENT COMMITTEE

Sometimes things happen as they do because that’s the way they’ve always been done. But things change – and are constantly changing.

An important part of investment governance is ensuring decisions get made by those who are well qualified to make them and have the time and resources to do so. Good investment governance requires clarity as to which investment decisions the Board will make and which will be delegated.

For example, it’s now accepted that fiduciaries shouldn’t pick stocks. Stock-picking is delegated to a professional fund manager. There are a multitude of other investment decisions to be made – what about manager selection, dynamic asset allocation, strategic asset allocation, stock exclusions, illiquidity allocation, fee budget, risk profile, new asset classes...?

The Board must make some investment decisions, but clearly not all. This means from time to time the Board or its Investment Committee should ask itself: “Should we be doing this?”. If not, delegate and then spend your time and resources monitoring the provider to ensure they are doing what they’ve been asked to do.
 

7. WHAT QUESTIONS SHOULD WE ASK?

QUESTION FOR YOUR INVESTMENT CONSULTANT

It’s generally considered good practice to have your fund manager present to your Board or Investment Committee on a regular basis.

A good investment consultant will help you prepare for and make the most of these presentations by setting the scene and reminding you of the role the manager plays in your portfolio. This may include how much they invest for you, how long they’ve been investing for you, how they’ve performed and any current issues related to the manager or their investment strategy.

This is where our next question comes in. A good consultant will arm you with some questions to ask. If not, before a presentation you should ask them: “What questions should we ask?”. That way, in the event that the presentation itself doesn’t spark any questions, you will look engaged and informed.

More importantly, it’s worth remembering that it’s your agenda. The fund manager will most likely want to talk about things that make them look good and shy away from awkward issues. Having prepared some questions ahead of time will help you drive the agenda and get what you need from the presentation, not just what the manager wants to provide. 
 

8. WHAT’S HOLDING OUR PORTFOLIO BACK?

QUESTION FOR YOUR FUND MANAGER / INVESTMENT CONSULTANT

This question demands a degree of bravery, both from the questioner and interviewee. If you think you are on top of your investment portfolio, how about asking, “What’s holding our portfolio back?”.

It may be that you’re not taking enough risk, or that you’ve ‘fallen in love with’ a manager that really needs replacing. It could be that you’re not allocating enough to illiquid assets or that your investment beliefs are not clear enough. Perhaps you have too many fund managers or aren’t diversified enough.

This question is probably best used as part of a review of a particular aspect of your investments (rather than just being dropped casually into general conversation). For example, as part of your asset allocation review, it might lead to a discussion about the merits of additional asset classes or adding to your illiquid asset allocation.
 

9. WHAT DOES SUCCESS LOOK LIKE?

QUESTION FOR YOUR FUND MANAGER / INVESTMENT CONSULTANT / BOARD / INVESTMENT COMMITTEE

Asking “What does success look like?” is a deceptively simple way to introduce clarity to a discussion or decision.

For example, it can be asked around the Board table when considering your risk profile. Framing the question in this way encourages you to describe the outcome, hopefully without resorting to impenetrable investment terms and numbers. Your consultant can then help translate what success looks like into investment and risk metrics. 

For a fund manager, asking the question can help you understand what to expect from a particular strategy. For example, success might be adding a modest margin over the market in the long term, with a particular focus on limiting losses in a market crisis. 

A corollary to this is “When might your investment strategy struggle?”. It’s accepted that different investment strategies work better, or worse, in different market conditions. Knowing when a particular strategy should work best and when it might struggle are important factors when monitoring investment performance.
 

10. ALMOST ANYTHING YOU WANT

In reality, you can and should ask almost anything you want.

No one likes to go first, but simply asking a question will signal to your colleagues that they can do the same. Once one person has asked a question, the floodgates will often open. Your query might not be particularly insightful, but the fact that you’ve asked it will encourage your fellow Board members to follow suit.

Remember that asking questions signals you’re in control. You want the provider addressing the issues that are important to you, in a manner you can understand. 

Passive attendance benefits almost no one, including the provider. You not only owe it to your beneficiaries and yourself to ensure you are doing your job, but also to ensure your provider is doing theirs. Asking questions is a great way of achieving this goal.

“When I had all the answers, the questions changed.”
- Paula Coelho

This article does not contain investment advice relating to your particular circumstances. No investment decision should be made based on this information without first obtaining appropriate professional advice and considering your circumstances.

 

 

[1] The 10 Questions were first trialled at the 2017 Philanthropy NZ Conference and then further refined at Mercer’s New Zealand Investment Forum in 2017. 

[2] This question reflects Mercer’s four factor manager research framework. Our first factor is ‘idea generation’, another way of expressing the notion that each manager must be able to generate a unique proposition for beating the market. We then examine ‘portfolio construction’ and ‘implementation’, which is all about being able to make money from this idea in a robust and repetitive fashion. Our fourth factor, ‘business management’, focuses on the business elements required to support and not hinder the investment process. To cap it off, our Environmental, Social and Governance (ESG) rating indicates the extent to which a manager incorporates these factors in their decision-making.
 

 


Mercer Australia
Wealth and Investments
Mercer Australia
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