End of Year Checklist #1 - Audit your money managers!

by Wayne Ferbert on December 2nd, 2013

The end of 2013 is on the horizon as December has finally arrived. With the end of the year comes the regular end of year investing articles – you know the ones I am talking about. The articles that both look backward at the year that was and look forward to next year. 
At Buy & Hedge, being good Catholics, we like to beat ourselves up and agonize over what we could have done better in the past year. In that regard, we are going to write multiple pieces in December about the end of year checklist you should be doing to get ready for 2014.
Checklist #1: Start to audit the money managers in your portfolio!
First, let’s start with the concept of an audit. Let’s remember – an audit is NOT a review of the performance of anything. When you get your financials audited as a company, you are not assessing whether the profit your company made was ‘good’ or ‘not good’.
Instead, an audit is a check of your processes and procedures. Think of it this way: an audit checks to see if you delivered XYZ results using the ABC procedures that you SAID you would use. An audit checks to see if you are doing things the way you SAID you would do them. In other words: are you delivering on your promise to operate in a certain way?
Your money manager should be reviewed with this audit approach in mind. The most important thing that a money manager can do for his clients: do what he says he is going to do.
What is the #1 sin in the money manager world? Style drift. What is style drift? It is when you identify the strategy you intend to follow as a money manager and then you instead allow your strategy to modify to a slightly different strategy. An example: the growth stock manager that buys too many value stocks. You hired him to be a growth manager – not a value manager. You have your value manager in another bucket – with another management company. You don’t want overlap.
But the audit needs to cover more than just style drift – its just style drift is the most common example of where a money manager fails in his audit. But money managers make all kinds of promises in how they are going to tactically manage your money – but once the bullets start flying, do they stick to those tactical promises?
Go back and read the marketing material that was provided to you from the money manager and even read the summary in the prospectus for your investment with that manager. Then look back on the year and ask yourself these questions: 
  1. Regardless of actual gains or losses, did this manager deliver the returns appropriate to the risk his strategy SAID it would take? 
  2. Was the risk taken in the strategy consistent in DESCRIPTION to the risk the manager described that the strategy would take? 
  3. Did the manager make any tactical moves or changes that were not consistent with his PROMISES?
These questions are not always easy to assess – but you can use Morningstar to help you. Morningstar assesses every money manager in its system and can provide you with a view of the manager’s consistency, his holdings, his risk, and his return compared to the appropriate benchmark.
What is the most telling sign that a manager is not consistent to his strategy? His returns or risk measurements deviate from the appropriate benchmarks for his strategy. Dive in to those managers a little closer than most!
You need to start thinking about the money managers in your portfolio going in to 2014. Remember that the money managers include the mutual fund manager for any funds you own as well as the RIA you might use that designs your allocation program. 

Began looking closely now - and you will be better positioned after the holidays to make the necessary changes to your portfolio in 2014!

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