Popat, a partner and leader of fiduciary management for growth markets at Mercer, works with discretionary mandates for institutional and high net worth clients in Asia and the Middle East.
Essentially, his team works on implementation of a client’s portfolio — identifying needs and appointing fund managers with the right strategies.
Step-by-step selection
He explained to FSA that the process of choosing fund managers begins with a global investment manager database that has 38,000 investment strategies. In going through the database, he considers a client’s current exposure and risk managment needs.
Although he looks for managers who Mercer has a familiarity with, he also considers other sources of information such as market intelligence. It results in a preliminary vetting.
Then the funds go through quantitative filters such as performance, alpha and volatility. With the selection narrowed down further, the next step is meetings with fund managers for a perspective on what they believe are the differentiating factors of the fund.
“We meet a lot of managers and they may present a differentiating story, but they may all claim the same differentiating story. It is easy to sell a good story but hard to deliver it.”
Therefore, he doesn’t rely on the people in the room. He and his team talk to the analysts, the risk team and the portfolio manager separately. “We then put the pieces together like a jigsaw.”
Going deeper
From there Mercer does a “four factor deep dive”. The first steps are sizing up how the manager identifies investment ideas and how the portfolio is constructed.
“Are ideas getting into the portfolio efficiently? How are they sizing those positions and how are they moving out of them?”
Next, how the manager integrates broad market risks. For example, with global small caps, how does the manager deal with illiquidity? In a very large fund, how does the manager get exposure to small stocks given the cost of trade?
The fourth factor is business management. How is the team motivated to focus on generating returns and how are they incentivized to stay with the firm? Is the lead portfolio manager out marketing or running the portfolio?
Bringing those four factors into the manager selection process, the firm comes up with a forward-looking rating based on the qualitative research.
Popat believes strong active managers can be found through Mercer’s process, despite the ongoing active versus passive fund debate.
“The active versus passive debate should be about how to bring the two together more efficiently, not about why use one over the other.”
Liquidity questions
In Asia, clients’ hunt for income remains a priority, but sourcing income assets has become more difficult, he said.
He suggests clients look at private market investments, to include private equity, private debt, infrastructure and real estate. They promise better returns than mutual funds but investors would have to stay illiquid in many cases for years.
For example, private debt gives distributions four years after investing.
“They may provide an attractive annualised return of around 8%, but capital is locked up for several years,” Popat said.
Specifically, he proposes secured credit products, an investment idea that helps fill the void created by banks being unable to provide financing.
“Since the financial crisis, regulations have stopped banks from lending in the same manner as they did previously. So an investor that can handle illiquidity can get a decent pickup in secured credits, around 75 basis points. It’s a private transaction, so it’s more complex. But risk is better because it’s a secured asset mortgage-backed security.”
An investment in secured credit can bring cash plus 2%-6%, he estimated.
“But these investments are not liquid. We challenge companies to review their liquidity budget. For years people have kept high liquidity, but by keeping that, the client is sacrificing potential for an additional pickup, a 2-3% illiquidity premium.”
