Active fund-management is a tough old game. To win this game you have to do at least three things really well, none of which is easy.
Firstly, to have any chance of outperforming your benchmark you have to construct a portfolio that’s different to your benchmark. You have to express non-consensus investment ideas in your portfolios. Secondly, and rather more tricky, your non-consensus ideas need to be proved right by the markets. You have to outsmart a lot of very smart and well-resourced people. Thirdly, perhaps most difficult, your clients need to remain committed to you until you are proved right. You need to retain your clients’ capital while you look wrong.
The first two requirements draw on your hard skills. This is where most of your competitors focus their efforts, which is understandable enough. The third requirement draws on your soft skills. The quality of your relationships with your clients is the piece that’s frequently neglected. This is an area that’s undervalued by your competitors, and therefore represents an opportunity for you to develop a sustainable competitive advantage.
Non-consensus views are essential for alpha generation, but they are a tough sell to your clients precisely because such views will be dissonant with prevailing orthodoxy. Most of your clients, by definition, will reflect the average opinion, which means that most of your clients will feel uncomfortable with your non-consensus views. Their discomfort will constrain your ability to implement these ideas with their capital.
But even if you have the courage to overcome these initial constraints, it’s not enough. You will need time for your investment thesis to unfold, but markets can withhold their rewards for longer than your clients can remain patient. During your inevitable periods of underperformance, that awkward air-pocket of time before you are proved right, everything will depend on the quality of relationship that you have with your clients.
Your clients’ commitment to you is constantly being tested, even at the best of times. They are subject to multiple sources of noise that interfere with their commitment. A period of underperformance only increases the relative attractiveness of competing managers, strategies, and products. If you have not built and maintained these relationships your clients will take away the capital that you need to express your non-consensus view, or they will take away the time that you need to be proved right.
You can hedge this risk, buttress yourself against an erosion of commitment, by getting to know your clients better. Develop a deeper understanding of the needs and concerns of your clients, beyond what is captured in an investment policy document. Address those needs and concerns on a proactive and personal basis. In the process, your clients will get to know you better too. Knowing each other is a massive competitive advantage. When the doors are closed and the board of trustees is deciding whether to fire you over poor performance, you need someone in the room to stick their neck out for you. They will only do that if they know you.
- How well do you know your key clients? How might you get to know them better?
- How well do they know you? How might you enable them to know you better?
- When will you start?