Balancing Risk and Reward: Manager Research and Due Diligence
The best investments don’t come with fail-safe guarantees; there’s always an element of risk.
In Canada, between 1970 and 2015, the rate of return on guaranteed investments was 5.25%. In the last few years, extraordinary moves by the world’s central banks have caused the return of these investments drop to approximately 0.5%. In an attempt to generate higher returns, investors have increased their allocation to risk assets. They have also added a range of non-traditional assets to their portfolios, to generate return from different sources of risk.
Building a portfolio that adequately balances risk and return is harder than ever. So, where do you start?
Manager research begins by seeking out investment strategies that serve a specific role within a family’s portfolio. That means meeting with and tracking managers over time, requesting and reviewing data as well as looking at potential risks and peer comparisons. Understanding repeatability and process maximizes the odds that an investment will behave as it is intended through market cycles.
For ultra-high net worth families, the biggest investment risk is outsized losses, so the design of a family’s asset mix and selection of managers is often about understanding that risk of loss. No advisor can prevent investment losses, but by identifying strategies or managers with a proven record of limiting those losses during downturns builds wealth over time.
Manager research involves asking the right questions while conducting thorough due diligence. Respect for managers is key, but it’s also vital to ask probing questions that may seem intrusive if they reveal important insights. Understanding the key areas to explore is crucial, but it’s equally important to be perceptive to responses. When there’s discomfort around discussing certain strategies or risk management aspects, it’s essential to continue probing to uncover critical information that could impact decision-making.
Where many wealth management firms outsource research and due diligence functions, Richter’s all occur in-house. Identifying the best strategies for clients can take months or even years. When Sathiyamoorthy and his team identify new managers, those individuals undergo an exhaustive due-diligence process to emanate elements of risk and ensure they will perform as expected. That vetting includes background, reference and police checks in multiple jurisdictions.
No advisor can prevent investment losses, but by identifying strategies or managers with a proven record of limiting those losses during downturns builds wealth over time.
Richter employs five core stages to approve a new manager or strategy, a process which can take many months – even years – to complete. Potential managers may be eliminated at any point in the process.
IDENTIFY STRATEGIES
A robust flow of investment ideas come from multiple domestic, U.S. and international sources, including capital introduction teams, third-party marketers, unsolicited inbound requests and the networks of Richter Family Office partners and colleagues.
GATHER INFORMATION
After an initial meeting or call with an interesting manager, Richter tracks and monitors manager performance across market conditions and places periodic calls to understand performance. This “staging area” for new strategies or replacement managers can take months or years.
PRELIMINARY DILIGENCE
Involves meetings, calls, and data requests. A “screening memo” describes the strategy, returns, risks and more to assess attractiveness of the strategy and suitability to family portfolios. This is discussed at the firm’s 10-member Investment Committee meeting to ascertain relevance across family portfolios. If approved at the preliminary stage by the committee, a strategy enters a deep due-diligence stage.
DEEP DUE DILIGENCE
Richter also reviews the tax implications of the investment, including how the income is earned or return is generated, the structure under which the investment is housed and how the Canadian Revenue Agency will view income or capital flows. It also ascertains any compliance requirements that might befall investors in non-Canadian investment opportunities and weighs these against the potential returns. Often families find themselves in complex, non-liquid strategies that attract significant compliance costs associated with federal and state tax filings in the United States, effectively handicapping after-tax returns.
Operational due diligence is also undertaken. This involves more meetings, more calls, on-site visits, and more data requests. Investment due diligence includes firm’s and principals’ background and experience. An extensive research report is generated and reviewed again at the Investment Committee level.
APPROVAL
Once approved by the Investment Committee, negotiations begin with managers for more attractive client fees or liquidity terms. Final approval is required from Richter’s Chief Compliance Officer before the manager/investment is proposed to families who make the final decision on whether or not an investment is made.
All research reports are all available and presented to clients for review. Once an investment is made, the team continues to monitor the manager to understand what is driving current portfolio returns and to determine if there are any material changes that might flag a future problem.
“The process by which we make recommendations regarding which parties serve the clients’ [financial] objectives is where trust is built,” says Danny Ritter, a partner at Richter Family Office, one of Canada’s largest fully-independent multi-family offices. “Fiduciary duty is paramount and independent status and open-architecture means we’re agnostic to the investments we look at. We really can find the best opportunities for families.”
For example, in 2008, when the Dow Jones Composite Index lost nearly one-third of its value, the investment team at Richter became intrigued with a manager whose portfolio of stocks fell only 7.5%. After taking considerable time to learn more about that manager’s approach they now represent a significant allocation across their families’ portfolios. Over time, they have significantly outperformed the market, but not because they are so successful in good markets. It’s because they lose so much less in down markets.
The reality today is that investors are more easily enticed into less transparent investment opportunities, lured by the prospect of “non-correlated” returns or compelling income generation. Such investments are often characterized by limited liquidity or long-term lock-up periods which may be appropriate for large pools of family capital, however, there is no quick exit should strategies not proceed as expected.
Having a partner that can help families independently navigate and access the increasingly complex array of investments is one of the key benefits of working with a well-establish multi-family office.
Richter Family Office’s integrated, holistic approach places a family’s needs at the centre of decision making to balance risk, reward and preserve a legacy over multiple generations.
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