Money Manager Due Diligence Scott Thoma, CFA

The Challenge  > 7,000 Separately Managed Account Options  > 7,000 Distinct Mutual Funds (> 25,000 when incorporating share classes)

The Challenge  Investors judge on short-term performance  Fiduciary duty?  Urge to "do something"

How Do You Conduct Manager Screens?  4 P's  Performance

How Do You Conduct Manager Screens?  4 P's  Performance  Historical  Risk-adjusted  Star rankings  People  Philosophy  Portfolio

Universe (7,000+ Funds) Mutual Fund Selection Process Target Universe Identify managers with records of performance success Judge whether success is repeatable Selection Evaluate factors leading to success Removal Change in thesis Better alternative List of Approved Managers Investment thesis Team discussion PeopleProcessPortfolio characteristics Rolling period performanceRisk-adjusted performancePerformance Attribution

Manager Initiation - RFI Process  Personnel -Changes in structure, coverage, resources  Process  Portfolio structure & philosophy  Ownership

Qualitative Analysis  Level of experience  Key decision makers  Resources  Performance and financial incentives

Qualitative Questions  How does the portfolio management team identify attractive investment ideas?  How does the investment team build the mutual fund portfolio?  Does the investment process make sense?  Is the overall investment process repeatable?

Investors Chase Performance Source: Ned Davis Research, Inc.

Rolling Period Analysis – Fund A  Morningstar Rankings (end of 2008)  1-Yr: 97 th Percentile  3-Yr: 96 th Percentile  5-Yr: 91 st Percentile  Rolling Period Return Analysis  Fund outperformed its benchmark and peers in 88% and 99% of 5-year rolling periods, respectively.  Outperformed its benchmark and peers in 76% and 86% of 3-year periods, respectively.  10-Yr Morningstar Ranking: 9 th Percentile Source: Morningstar

Portfolio…Or Collection of Funds Source: Morningstar

Differences in Styles Leads to Differences in Performance Fall/Winter 2008 Deep Value Underperforms Eclectic & Conservative Managers Outperformed Spring/Summer 2009 Deep Value Outperforms High Quality Underperforms

Understanding Fund Differences International Fund Performance Differences  Emerging markets allocations  Currency hedging

Importance of Understanding Fund Differences Source: Morningstar

Periods of Relative Underperformance vs. S&P500 Rolling 1-Year Periods Top Quartile Managers Q1 1998–Q Past performance does not guarantee future results. Universe—Large-Cap domestic equity; 164 large-cap managers whose 10 year average annualized performance ranked in the top quartile from January 1, 1998– December 31, 2008 were analyzed. Source: Factest, PSN and AllianceBernstein Even Top Managers Endure Tough Times

Periods of Relative Underperformance vs. S&P500 Rolling 3-Year Periods Top Quartile Managers Q1 1998–Q Past performance does not guarantee future results. Universe—Large-Cap domestic equity; 164 large-cap managers whose 10 year average annualized performance ranked in the top quartile from January 1, 1998– December 31, 2008 were analyzed. Source: Factest, PSN and AllianceBernstein Even Top Managers Endure Tough Times

% whose Rolling 1-Year Performance Fell into the Bottom of the Rankings Top Quartile Managers Q1 1998–Q Past performance does not guarantee future results. Universe—Large-Cap domestic equity; 164 large-cap managers whose 10 year average annualized performance ranked in the top quartile from January 1, 1998– December 31, 2008 were analyzed. Source: Factest, PSN and AllianceBernstein

Consistent Performance Is Elusive: Even Top Managers Endure Tough Times % whose Rolling 3-Year Performance Fell into the Bottom of the Rankings Top Quartile Managers Q1 1998–Q Past performance does not guarantee future results. Universe—Large-Cap domestic equity; 164 large-cap managers whose 10 year average annualized performance ranked in the top quartile from January 1, 1998– December 31, 2008 were analyzed. Source: Factest, PSN and AllianceBernstein

Detailed Performance Review  Peer review  Attribution analysis  Drift

Drivers for Removal  A significant negative change to the fund's portfolio management team  A significant change to the fund's investment process  Investment style or investment process drift  A better alternative within the same asset class  Underperformance (relative to style and process)

Issues With Star Rankings  Portfolio/Style Bias  Short-term Performance Bias  Share Class Bias  Category Changes  Manager Changes

Issues With Star Rankings  Not predictive of future performance “In short, the star rating is a backward-looking measure of past performance. What it is not is a forward-looking measure of fundamentals.” - Russell Kinnel, Morningstar

Regulatory Issues  Fiduciary Standard  Target date funds  12b-1

The Challenge  Number of options  Evaluating performance  Urge to "do something"  Time / resources

The Opportunity  Standard process for evaluation  Better decision making process  Better portfolios  Better client experience

Questions / Comments?