There's only one way to see things -- until someone shows you differently. Ronald Surz is president of PPCA, a San Clemente, Calif.-based software firm that provides performance-evaluation and attribution analytics, and a principal of RCG Capital Partners, a Denver, Colo.-based fund-of-hedge-funds manager.

The way the hunt for investment talent is being conducted these days reminds me of the old joke about the drunk looking for his car keys at night under the light of a lamppost.

"Are you sure you dropped them here?" asks the good Samaritan who had stopped, some time earlier, to help the inebriate.

"Naw, I dropped them back in there," says the drunk, pointing vaguely into the black recesses of an alley a half a block back. "But the light's much better here."

Skill first

When it comes to investment-fund selection and allocation, financial consultants are doing what's easy rather than what makes sense. They ought to be customizing the benchmark rather than limiting their comparisons to off-the-shelf indexes, like the Russell and the S&P, and they should allocate to talent rather than to style boxes.

Consultant fund selection criteria favor index funds and index huggers. The consulting industry has drunk the index huggers' cool aid, and has reversed a process that had been in place for some time.

Not too long ago, consultants sought skill wherever they could find it. Then once a talent pool was filled, allocations across this pool were optimized for diversification. Risk was defined, in the aggregate, as failure to achieve objectives. Frank Sortino, director of the Pension Research Institute, continues this tradition with his latest work.

By contrast, today's equity allocations are pre-ordained to set style boxes, each with their own index, and managers are sought to track these indexes. Risk is defined at the individual manager level as tracking error.

Square pegs

If -- and this is a proverbially large "if" -- some non-index managers have skill, this framework built for index huggers will not find them.

Performance evaluators who limit their analyses to standard off-the-shelf indexes will routinely make bad judgments regarding liberated non-index-huggers, declaring losers to be winners, and failures to be successes.

Treating everyone as if they were an index hugger is an evaluation mistake. We need to bring the best custom benchmark to each liberated manager, rather than force these square pegs into round holes.

Otherwise we'll miss a lot of talent. Some investment firms are simply at their best when left unfettered from indexes. This doesn't take these firms off the benchmark hook; it customizes the hook.

Trolling for talent isn't as easy as some think, unless the only catch you're after is an index hugger.

And no offense to index huggers is meant here: some of my best friends love their indexes. -FWR

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