Clint Eastwood, Johan Cruyff, Ivan Lendl – these are all people who have switched sides in their professions with commensurate benefits in the process. Eastwood’s case is particularly compelling with two Oscars for best director under his belt.
Do such advantages translate work into the world of investment? Ecuador native Jaime Arguello thinks so. He has a 30-year career in both fund management and fund selection and believes this dual experience gives him a defining edge when it comes identifying the best fund manager talent.
‘Since I first moved over to manager selection in 2005 at Pictet, I have always been quite selective about who I go and see. I usually spend a fair amount of time analysing the fund investment process and performance patterns. If there were characteristics I knew wouldn’t fit my criteria then I simply didn’t need to see the portfolio manager,’ he says.
‘I am asked if having to initially field questions as a fund manager now makes me a more incisive questioner? The answer is “yes”. I have now met hundreds of top portfolio managers and each time, I went in knowing what the priority areas to investigate had to be.
‘Even if it looks like those priorities are there, I will challenge assumptions, especially around risk taking. For example, portfolio managers will try and talk through their process but we will be looking at how well they have forecasted outcomes and what type of risk-taking approach they have.
‘These are some of the key elements to explore before you invest and I would have needed to consider them myself as a portfolio manager.’
Plotting a course
As CIO for Architas, London-based Arguello now oversees £20 billion (€21.8 billion) in assets through the company’s investment team, which covers managed portfolios, multi-asset strategies and multi-management operations.
The London-based investor cut his teeth on the bonds desk at Société Générale in Paris, where he worked as a portfolio manager for two years.
A brief sojourn into the world of derivatives led him back into fund management in 1991 with Credit Lyonnais Asset Management, where he worked as a senior portfolio manager within fixed income. Arguello then had his first taste of senior management in 1994, when he joined CPR Asset Management to oversee its bond manager team.
‘As head of the team, I managed a number of strategies across global fixed income, investment grade, high yield, emerging debt and some short-term absolute return products. These were the same functions I assumed when I joined Pictet as head of fixed income in Geneva in 1998.’
After seven years steering the Swiss group’s bond efforts, Arguello was offered the chance to ‘cross over’ when he was asked to spearhead the private bank’s first manager selection team. He jumped at the chance.
‘I knew about all aspects of fixed income portfolio management, so I was always interested in enhancing my experience with other asset classes. I was convinced that having managed portfolios for 20 years across different companies and having been grilled by dozens of fund selectors I could make a difference by moving to the other side.
‘I thought I could use those insider’s skills to my advantage. In addition, having hired a large number of portfolio managers and analysts for various investment teams provides useful experience in evaluating talent,’ he says.
Arguello says selecting a stock or bond is based on measureable returns or performance which could be for a just a short period if necessary. However, when you are creating a team, you must keep the long-term in mind and the same applies when you select individual managers, as you must approach them with a keen eye on the time horizon, he says.
Edits and improvements
So, what stops all fund managers making the leap from alpha-generator to gatekeeper? Arguello points to some key differences between the roles: ‘One thing that changes is you suddenly have access to the whole industry. When you are a fund manager you might know a little about what your peers are doing but not in much detail. However, a fund selector needs that extra level of information.
‘It also might be because the fund selection role is perceived to be less technical and specialised than selecting and allocating risk to individual securities. When we invest in funds we obviously don’t select specific idiosyncratic risk but instead invest in teams, so the skills are a bit different.
‘We are fund managers but our investment approach is a combination of asset allocation with the ability to allocate capital to carefully selected specialists by asset class.’
Arguello also thinks the variety of his earlier career, which covered lots of different working environments and cultures, has also helped him. This, coupled with his gradual move from manager to team leader, made him more capable of starring in a new role. But what advice would he offer to other fund managers wanting to cross the divide?
‘You need to be quite open to other processes, because generally you will have learned to invest in a particular way. But you’ll soon realise there are other and better ways of doing things.
So you need to be flexible. You also need a fine nose for talent, to find managers before they close to new investors. You may be restricted by the fees you are allowed to absorb but you should be prepared to pay for investment quality,’ he says.
Arguello cut his teeth as a bond manager and so recognised the fact that he needed a broader skill set when he moved over to cover the full remit of fund selection. He therefore did further training in equity, both in terms of valuations and also in simply meeting managers.
While there were similarities in valuation methods between high yield bonds and equities, Arguello says he was keen to properly develop his expertise across different asset classes. This also meant adding to his growing knowledge in areas such as alternatives.
Cutting room floor
Some selectors believe fund managers are now more focused on a flashy pitch than the end product, and while Arguello says there’s some truth in this view, he thinks there’s more to the story.
‘Managers are becoming better and better at presenting, so selectors need to work that much harder to get beyond the mere pitch, which can be very cosmetic. Sometimes you meet a fund manager who is a good salesman so you need to dig deeper to identify an investment team’s real skills.
‘Fund managers will often have a set way in which to present a product but the reality is always more complex and some factors need to be prioritised. As part of the due diligence, we try to read the portfolio manager’s body language and gauge reactions to see if they are uncomfortable answering particular questions.’
However, one thing Arguello doesn’t believe is worth doing is grilling fund managers aggressively, as he didn’t find this a useful tactic when questioned as a manager himself. However, he says there is a difference between grilling someone and provoking a response.
‘We recently asked a manager more targeted, tougher questions than usual and they didn’t deal with it very well. That’s a bad sign and sets you wondering if they will respond equally badly when their performance comes under pressure,’ he says.
Arguello says a large amount of preparatory work should potentially remove unwanted surprises when you are finally sat down face-to-face with a prospective fund manager.
‘We analyse the investment process before meeting the investment team but on-site meetings are essential as they can be illuminating from a behavioural perspective. Once capital is allocated to a fund, initial assumptions gathered during the due diligence phase are confirmed or revised based on the analysis of investment decisions.’
Arguello can obviously empathise with managers going through periods of underperformance and he is reluctant to set rigid boundaries. However, there are certain signals he watches for that could indicate something more worrying.
‘No manager outperforms in all market phases but what’s important is to stick to your process during times of difficulty.
‘From a selector’s perspective it’s key to identify the scenarios in which the manager can underperform and to what level.’
Arguello says there needs to be an understanding of what sort of underperformance is tolerable and what isn’t. He highlights how a manager having a crisis of confidence after a period of underperformance could begin to take undue risks, which would ring alarm bells for Arguello and his team.
‘If a manager crumbles under pressure and reduces risk for a prolonged period of time it could be a red flag. We have seen cases on the other side where managers outperform hugely because they have concentrated too much risk and that could also be a reason to reconsider our investment.’
The hot topic in fund management at present is the rise of robotics, an issue we explored last month with Union Investments’ Jörg Schmidt. Does Arguello believe his hard-earned insight from the frontline of fund management will no longer have the same cache if he is left only to interact with quants and scientists?
‘This is not new. We have dealt with quant and systematic funds for years. What will always be important is to understand the logic of the model, even if the overall approach is a bit complex,’ he says.
‘There will be humans designing models and we need to think about their involvement, what approach are they using? How involved are they once the system is set? How will they improve it and how can they change elements of it?
‘Like any fund, you want to understand operations and performance. This goes for traditional and systematic funds, if you have a fund which isn’t transparent enough, then why would you invest in it?’
But just as fund managers are under pressure from quant-led approaches, Arguello doesn’t think fund selectors should be complacent.
‘Quant selectors could emerge and some outfits are already using systems to select managers based purely on analysis of historical metrics of performance and risk. At the moment this process is relatively straightforward and it has yet to incorporate more nuanced elements of fund manager selection.’
Arguello adds: ‘In particular, the behavioural component of investment due diligence might be more complex to model. Machines haven’t got there yet.’
This feature originally appeared in the September edition of Citywire Selector.