INVESTMENT PROCESS

IN THE BEGINNING

If the product of a fund management business is its fund range, that of an investment team is the investment performance of the fund or funds it manages.

Having a sound investment process is more important than it used to be. Computers are increasingly able to find and take advantage of patterns in data and to do this more effectively than the human fund manager. Clients are no longer satisfied with good performance alone – they must see that there is a sound process behind the numbers. Indeed, they may tolerate sub-benchmark fund performance if they deem it to be the result of exogenous factors rather than the absence of a sound investment process.

The word product derives from the Latin duco meaning to draw, pull, lead, guide, think, consider. Commercial products in any industry are the result of a production process which encompasses both the beliefs and thinking that shape the design of a product as well as the operational steps that add value to raw materials.

PHILOSOPHY AND PROCESS, PHILOSOPHY IS PROCESS

For an investment team, these two aspects are called the investment philosophy and the investment process. Although they tend to be considered separately, they are inextricably linked, and it is better to consider an investment philosophy as the first part of the investment process. After all, it would be impossible for a manufacturing company to build a production line without first having carried out R&D or having other core beliefs in place regarding, say, product quality.

The aim of an investment team is for the funds it manages to achieve their performance objectives. This in some way will involve beating the market and there are many ways to do this – there are also many ways to get beaten by the market! How an investment team believes the prices of financial assets can be predicted is called investment style. Examples of style include momentum, value, growth, and style represents the main aspect of investment philosophy. Is a style top down, associated with one or more systematic factors? Or is a style bottom up, seeking to capture purely idiosyncratic price movements? Or, as is often the case, a combination of the two?

Importantly, a belief in a particular investment style should have intellectual support. After all, fund management companies are not religious cults, or at least they shouldn’t be! Proper statistical testing of a style should have been conducted if the objective is to construct a sound investment process.

Other aspects of philosophy might include beliefs about how many different styles should be combined with respect to a particular fund or range of funds.

Styles can be technical, looking only at market prices with little if any regard for the entity that is being priced. Others can be fundamental and involve an appraisal of the underlying entity, a company, or a commodity for example.

THE OPERATIONAL SIDE OF PROCESS

The second part of an investment process, the operational part, lays out how investment buy and sell decisions are made. And investment decisions collectively determine how a fund will perform.

If information is the raw material, how a fund manager turns this information into investment decisions to buy or sell constitutes what is happening on the production line i.e., the operational side of the investment process. In addition to investment style or styles, what other boundaries are fund managers subject to? In relation to research, do fund managers work individually or in groups? Are fund managers’ investment recommendations subject to scrutiny or approval before they can become decisions? Or do the fund managers have a high degree of autonomy, subject to previously agreed rules rather than the scrutiny of colleagues or committees?

RISK AND PROCESS, RISK IS PROCESs

Alongside the investment process and its objectives comes the risk that the objectives are not achieved. Risks be determined, appraised, then managed. What categories do risks fall into? What are each of the specific risks? Should they be managed internally by the investment team or externally or both? Indeed, risk management should, like philosophy, be considered part of the investment process, not separate to it.

THE BEGINNING OF A NEW BEGINNINg

There are many aspects to an investment process. A sound process should be tested, sustainable, scalable, and repeatable. Synthesist Ltd can provide an independent appraisal of one, several or all aspects of your investment process, or help you to put a new one in place.