I’m happy to share that last week was my two-year anniversary with QV Investors. Prior to joining the firm, the majority of my 30+ years of experience in the financial industry was focused on researching asset managers. Although that is no longer my role, I frequently get asked what makes a successful asset manager. Ultimately there is no simple answer, but I thought I would share some of what I learned after 18 years and 700 meetings with asset managers. Note that these beliefs are based on my experience and not necessarily representative of the firms that I worked for at the time.
A SUMMARY OF KEY TRAITS
Independence: I always preferred firms that were independent with ownership broadly distributed and where the investment team is motivated to make objective investment recommendations in a less bureaucratic environment with no outside influences.
Alignment of Interests: I viewed firms positively where investment professionals are personally invested in the strategies they managed. I think it’s important to have skin in the game to ensure the manager is invested alongside their clients.
Strong Organizational Culture with Committed Leadership: This is critical because a poor culture can lead to significant personnel turnover and a lack of motivation.
Concentrated Funds: I have always believed in active management, so I preferred more concentrated strategies with fewer companies rather than index-like funds. A key component though is the asset manager needs to have skill in stock selection.
Clear Investment Philosophy with Deep, Bottom-Up Research: I was told many times by asset managers that their investment philosophy was to “buy good companies” and that was all they articulated. This is not enough. It was important that there were more components to the philosophy. They also needed to demonstrate they had the skill to do in-depth research to uncover these factors.
Efficient Decision-Making Structure: Clear accountability for final decisions is important. I was never a fan of firms that required a consensus to make portfolio changes, because it slows down decision making.
Thoughtful Portfolio Construction: Asset managers needed to demonstrate a thoughtful and consistent approach to portfolio construction with clear guidelines. Highest conviction stock ideas should have the highest weights.
Strong Risk Management: Managers need to be aware of all risks in the portfolio whether unintended or intentional. There should also be a process in place to identify these risks and monitor them.
Sticking to Your Knitting: Not deviating from the investment philosophy, beliefs and approach during difficult times is a key trait.
THE CHALLENGES OF STICKING TO YOUR KNITTING
Now that I’ve worked for an asset manager on “the other side” for the last couple of years, I’ve come to appreciate the difficulty of sticking to your knitting when performance is challenged. Clients may leave if the asset manager’s philosophy is out of favour, resulting in a decline in firm assets under management. The challenges are even greater in a concentrated market like what we have in Canada, where not owning certain specific stocks or sectors that are outperforming, can really hurt short-term performance.
As a manager research analyst, I observed these struggles on many occasions with stocks such as Shopify (which has been discussed in previous QV Updates), or back in early 2008 when I observed a value manager adding RIM (Blackberry) and Potash after strong runs in 2007.
The temptation for managers to jump on board those stocks, even if they don’t fit with their investment philosophy, is significant. In my opinion, it’s the wrong thing to do as it shows a lack of commitment to the investment philosophy. It may also have negative performance impacts when invariably, the manager’s style comes back in favour.
PROOF THAT STICKING WITH YOUR KNITTING PAYS OFF
QV experienced performance struggles in the QV Canadian equity strategy from 2016-2020. These struggles were due to several factors, including the value style of investing being out of favour. This is highlighted in the chart below. The QV Canadian Equity Fund lagged the benchmark by 4.0% over the five-year period but by sticking with our investment philosophy and approach, the Fund rebounded strongly in 2021 and 2022, being almost 7% ahead of the benchmark on an annualized basis over those two years.
It’s worth pointing out that even with these challenging periods, sticking to our philosophy has led to outperformance in the QV Canadian Equity Fund over the long term with the 10-, 15- and 20-year performance being ahead of the benchmark.
Benchmark: S&P/TSX Composite TR Index
It’s also worth highlighting the Technology Bubble back in 1999, when not owning dot com stocks was extremely problematic for value managers. In the QV Canadian small cap strategy, the investment team did not give into the pressure despite performance challenges. The chart below shows how strong the rebound was in the three years following the Dot Com Bubble.
Benchmark: BMO Small Cap Blended (unwtd) Index
It should come as no surprise that QV embodies the traits I valued as a manager research analyst. After being on both sides of the table, it is even more clear to me that not deviating from your investment philosophy and approach during challenging times is key to avoiding investment style drift and will enhance returns in the long term. At QV, we believe in the investment philosophy and our 26-year history shows that we have stayed disciplined during challenging market environments. Our long-term performance pattern across the QV strategies proves this approach has been successful for our clients.
All returns stated are gross of fees.