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Portfolio Management and Performance

Independent directors evaluate a fund’s investment performance on an ongoing basis. This does not mean that directors second-guess the portfolio manager’s decisions to buy or sell particular securities. Rather, the directors look at a fund’s performance as a whole and over time, taking into consideration its investment objectives, strategies, and risks to evaluate whether the fund is meeting its stated objectives. An important element of a board’s ability to do this is to receive periodic presentations and detailed written material from portfolio managers. While review of fund performance is an integral part of the advisory contract renewal process, boards generally do not limit their review of fund performance to contract renewal time. Instead, review of fund performance typically happens, in some fashion, at every meeting.

The following questions may help new directors initially familiarize themselves with fund portfolio management and performance:

  • What is the fund’s objective and strategy?
  • What are the benchmarks and peer groups against which performance is compared?
  • What is the portfolio manager’s investment and risk management process?
  • What is the investment selection process?
  • What are the sources of returns and risks, relative to the fund’s benchmark?
  • What kind of volatility is associated with the fund?
  • What are the fund’s concentration and diversification policies?
  • What are the fund’s investment guidelines and restrictions?
  • Does the fund use derivatives? If so, what types? How are they monitored?

Directors also will want to understand the structure of the adviser’s organization as it relates to the oversight of fund performance. Some of the questions directors may wish to ask include the following:

  • What groups or individuals within the advisory firm are responsible for portfolio manager selection and ongoing monitoring and evaluation?
  • If the fund complex uses portfolio managers employed by the adviser and a subadviser, is the same group within the adviser’s organization responsible for selection and evaluation of both? Are the same criteria used for both? How are subadvisory fees determined?
  • What are the reporting lines for portfolio management?
  • How is portfolio manager compensation structured? What incentives do portfolio managers have to seek superior performance?
  • Are portfolio managers required to invest in the funds they manage?
  • Is there a performance “watch list”? If so, what are the criteria for placing a fund on it and taking remedial action, if necessary?
  • Does the adviser devote adequate resources to the management of the fund?

In evaluating whether the fund is being managed consistently with its mandate as well as whether the fund’s investment performance has been satisfactory, the board’s primary considerations may include the following elements:

  • Relative performance. How did the fund perform relative to its benchmarks and peers?
  • Risk-adjusted performance. Did the active management add sufficient value to justify the added risk relative to the benchmarks (or passive investment alternatives)?
  • Market experience. Did the fund perform as expected in the actual market and economic environment?
  • Reasons for over- or underperformance. What were the primary reasons for the fund’s performance relative to its benchmark and peer group, and were these consistent with the expectations discussed by the adviser with the board?
  • Portfolio structure and risk. Was the fund’s portfolio structure consistent with disclosures and guidelines in terms of exposures, concentration, and risk relative to the benchmark?
  • Investment process. Did the portfolio managers follow their stated investment process, including selection and allocation of fund holdings?
  • Implementation. Did the portfolio managers efficiently implement their investment strategy, including prompt investment of cash, use of derivatives as appropriate, and control of turnover and transaction costs?
  • Lessons learned/changes. In light of market experience, are the portfolio managers or senior management considering any changes to the investment process or portfolio structure?