Understanding best practices helps plan sponsors ensure that their investment managers measure up.

Have you ever wondered how your investment managers’ processes stack up against world-class standards? Your investment consultant provides one means of assessing the strength of your managers. But these efforts are directed toward finding the Best in Show without really identifying what constitutes “best.”

Highstreet Asset Management interviewed more than 70 industry participants, including senior professionals (such as chief executive officers and chief investment officers) from investment managers, pension consultants, managers of managers, plan sponsors, brokerage houses and service providers. Each interview focused on just one question: What do you feel constitutes best practices within a quantitative investment process?

The implications of this research are obvious for quantitative asset managers but are equally important for plan sponsors, whether they are selecting fundamental, top-down, value, growth or quantitative managers. Based on the results, here are some investment manager best practices that plan sponsors should look for.

Transparent operations – Investment managers must be able to describe their investment methodologies and regularly prove their adherence to that description. Plan sponsors should insist that managers be ready to answer questions about how securities are selected and how portfolios are constructed. An investment manager should also have documentation available that outlines the research approach. Traditional managers should identify their sources of information and internal ranking processes. Quantitative managers must be able to demonstrate which factors they use and how those factors were determined. Both manager types should have a research protocol to be used in idea generation for security selection, portfolio construction methods and the specific rules in the manager’s sell discipline.

Plan sponsors should also ask to view an historical change document that tracks any and all changes to the investment process, the quantitative models and/or the management team. The plan sponsor should be able to understand why a particular change occurred and review the results of that change.

Sophisticated risk controls – Plan sponsors have imposed risk controls on investment managers in the past, but these controls usually took the form of restrictions on security weights or sector exposures. Best practices for risk management within the industry have rapidly moved away from the old weight and sector allocation constraints to embrace a new set of measures. Now, most investment managers have adopted more sophisticated risk practices that incorporate a probabilistic approach to risk quantification. Plan sponsors must understand and adopt them as well, as these practices allow investment managers to fully utilize their skill sets, providing greater opportunity to add value.

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