Page 480 - DCAC February 2024 Files

How Quantitative Challenges Shape Investment

Evaluation: A Comprehensive Approach to

Due Diligence

Peter Girard
Manager

Most investment offerings inevitably encounter quantitative challenges
at some point in their lifecycle. Quantitative issues within the realm
of investment due diligence encompass all measurable aspects that
might signal problems from an investment management perspective.
These issues should not immediately trigger alarm but rather serve as
prompts for the crucial question: Why? This answer often comes from
a blend of quantitative and qualitative concerns. Quantitative analysis,
in isolation, provides only a monochromatic glimpse, like sketching management. Instead, it prompts us to investigate the “why” and
in black and white. A more robust analysis adopts a dual-pronged determine the best course of action within our client’s best interest.
approach, combining qualitative and quantitative due diligence, We never want to discourage portfolio managers from adhering to
which we believe brings deeper comprehension of cause-and-effect their investment process.
dynamics within our industry.
Consider a portfolio management team with a rigorous buy-and-hold
Asset Base
process that undertakes extensive due diligence, adding only a few
The asset base of a fund, sometimes referred to as assets under new companies to their equity portfolio over many years. They may
management (AUM), can fluctuate due to various factors, including experience significant drawdowns if their holdings don’t include a
market conditions, organizational or management matters, or given year’s hottest stocks. However, if the fund consistently executes
prevailing headlines. Examining asset flow across different timeframes its investment process over longer periods, generating excess returns
offers a more detailed narrative and indicates whether concerns over the benchmark, we should not harshly judge the team for
are immediate or longer term in nature. Given the current level of adhering to their investment philosophy, even if it doesn’t align with
available capital, we primarily inquire about each fund’s ability to short-term trends.
adhere to its investment process. Our research communicates any Fees
looming concern as soon as it becomes apparent that the asset level
might affect our client’s investment. Significant inflows or outflows can Management fees ultimately impact client portfolios and opting for
disrupt investment management, whether due to capital constraints, funds with lower fees means more money remains in the client’s
liquidity issues, or a scarcity of viable investment opportunities for the account. We compare a fund’s management fee to its peers to inform
manager to deploy capital. our clients about that fee relative to the broader universe comparable
investments. When a management fee exceeds 30% of the average fee
Performance
among peers, we consider it a minor concern and communicate this to
We consider investment performance in isolation as, at most, our clients, ensuring they are aware of potential cost savings through
something that gets us interested in the fund. We do not let short- alternative offerings.
term successes or failures overly influence our judgment of quality. Asset base, performance, and fees are all critical metrics, but our
Consistent with our “process over prediction” philosophy, we initially evaluation goes beyond these purely quantitative factors. We
evaluate performance over 3- and 5-year periods, which we believe understand that investment management is not merely about
offers a more tempered assessment. We also scrutinize performance numbers, but also strategy, philosophy, and adaptability. Our approach
across multiple calendar years and rolling 3-year periods. The 3-year emphasizes process over prediction and encourages us to ask the vital
performance metric in particular helps smooth out any abrupt question of “why” when confronted with challenges.
changes observed in annual performance. We compare a fund’s
performance both against its benchmark and its peers to ensure the Ultimately, our goal is to act in the best interests of our clients.
most comprehensive assessment possible. We aim to provide them with a well-informed, responsible, and
nuanced perspective on their investments. This approach allows us to
This multi-timeframe analysis promotes objectivity. While our confidently navigate the complexities of the financial landscape and
evaluation process may seem extensive, it’s merely our starting point. support our clients in achieving their financial goals.
Underperformance is not necessarily indicative of poor portfolio
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