Advisers should be asking at least four hard questions of fund managers

Advisers should be asking at least four hard questions of fund managers, a leading fund manager says.

Pengana Capital head of distribution Damian Crowley says correlation, manager skill, risk-metrics, and alignment are four of the crucial criteria that advisers should look for when choosing a fund manager.

“Most of Pengana’s funds have low or no correlation to market returns,’ says Crowley. ‘You don’t want the funds that you invest in to all have a high correlation to each other and the markets otherwise the diversification benefit is reduced.”

Manager skill is the second key question to ask, says Crowley. ‘How much of the return that has been generated is just from the market (i.e. beta) and how much is skill based or alpha?

“You want some of the funds you invest in to be truly active or benchmark-unaware and be able to go to cash or vary net market exposure to reduce the market risk of the portfolio.”

Third, the risk-metrics of a fund are important. These include its Sortino ratio, downside deviation, maximum drawdown, percentage outperformance in down markets, and percentage outperformance in up markets.

Fourth, Crowley says an adviser needs to check the fund manager’s alignment of interest with the portfolio and with the outcomes of the fund.

“So, properly structured performance fees are good for investors because you want to have incentives for the fund manager to perform that aligns the fund manager’s interest with investors’ interests. You want the fund manager to have an economic interest in the fund – that the fund manager owns ‘x’ and has a financial interest in the profit & loss.

“The fund manager has to have an economic interest and be incentivised.”