Most investors fail to select the right investment managers because they focus too much on past performance, says the wealth and investment management arm of Barclays.

The UK-listed bank believes that manager selection is a science as well as an art which should include thorough research and personal meetings. “The only way that past performance can give us a level of information is a diagnostic of how the investment process behaves in different market phases,” Jamie Arguello, director of multi-management at Barclays’ wealth arm, said at a media briefing in London.

“There is no manager that is going to outperform in every market phase, but it is important to have managers that behave as expected in different phases,” Arguello said. "It is very important to find managers that will give protection on the downside, because that is very important for our clients.

“When the markets are up by 10 or 20 per cent, we expect them to underperform because there will be more offensive buyers,” Arguello said. "But when it crashes by 20 per cent, that is when we expect them to outperform.”

Barclays has set out its approach to manager selection in a new white paper entitled The Science and Art of Manager Selection. “The troubling times that we all witnessed and experienced over the credit crunch, that period redefined the financial market landscape,” said director Oliver Gregson when introducing the report in London. “In many ways the traditional approach of managing multi-asset class portfolios for private clients fell down.”

“Private clients felt let down, frustrated and disillusioned by what they experienced from the industry,” said Gregson.

Risk-takers versus index-huggers

Barclays believes that the right fund manager can deliver highly-performing returns on a consistent basis even in periods of market stress, and that the ultimate element is investment talent. “You can always invest in an ETF if you don’t believe that the manager can generate alpha or if you want to take a short-term bet without the manager risk," he said. "But if you want to invest in an active manager and create performance versus the market, in equity, fixed income or hedge funds, then you need a process to identify the right manager.”

“In the past years, investment managers have been investing more and more in marketing," he said. "This can get you into believing that an asset manager is the best in the world, and this was different 20 years ago. Not only firms are now better at marketing but managers have also become better at promoting themselves. You really need to go beyond what the firm is showing and go much deeper in the process.”

Arguello highlights the importance of making bold decisions: “You will have many investors known as ‘index-huggers’ who do not express much conviction,” he said. “We tend to avoid those kinds of managers, we prefer true active managers who are not afraid to take risk.”

“For my experience of working as an asset manager for 15 years when confronted with manager selectors, very often the process is often like a check list to make sure that the firm has certain tools and performance reports,” Arguello said. “There is a very simplified way of selecting managers in the bulk of the industry.”

“The traditional long only equity/fixed income is a world where we have a very high level of transparency so we have access to information that allows us to go very deep into the analysis,” he said. “The hedge fund space is much less transparent, although there has been an improvement over time. That means that you need more interviews and visits to the managers in the hedge fund industry.”

Arguello pointed out the importance of monitoring managers once selected. “When to terminate a manager is of course a tricky question,” he said. “If the manager leaves the company and there is a key person risk, as when a lot depends on a high-conviction fund manager, then we need to exit immediately. If there is a change of ownership structure, we need to analyse that.”

“The more difficult factor is the performance;  if the manager is underperforming by a margin you expected, it is fine,” he said. “But if the margin becomes bigger and if you expect a performance of 3 to 4 per cent per year and after one year he has delivered 5 or 6 per cent. What has generally happened is that the manager has taken more risk or not implemented self-discipline. We then put the manager on watch for a couple of months.”