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Holistic Manager Diligence: Do the Parts Fit Together?
Adapted for endowment staff from Chapter 10 of The Single Family Office by Richard C. Wilson.
One CIO I interviewed for the book had met hundreds of hedge fund managers a year for close to a decade, and narrowed them down to a couple dozen he really believed in. I asked him what mattered most in diligence.
His answer was one word. Holistic.
The parts he looked at
- Team and its history together
- Incentive alignment
- Opportunity set
- Investment philosophy
- Strategy
- Process
- Risk management
- Attribution, meaning where the returns actually came from
His view was that past returns, even risk-adjusted ones, are a result of all those parts. If the parts fit, good returns tend to follow. If they don't, the numbers usually fall apart sooner or later.
A story he told
A well-known growth manager brought in a well-known value manager as co-portfolio manager. The idea was to diversify away from growth, which had been lagging.
Looked at as a whole, it was clear the two backgrounds, philosophies and risk approaches couldn't live in the same fund. Not long after, the value manager was out and the fund was restructured.
Each piece looked fine alone. Together they didn't work.
How endowment staff can use this
At the end of diligence, write one paragraph that connects the parts. For example:
"Small team that has worked together for years. Owners have most of their own money in the fund. Narrow opportunity set where size is a real edge. Process forces position limits. Attribution shows returns came from many names, not one."
If you can't write that paragraph without forcing it, something is off.
Questions that test fit
- Does the fund's size still match the opportunity set?
- Do the incentives reward the behavior the strategy needs?
- Would the risk rules have stopped the worst year from being worse?
Frequently asked questions
Is this only for hedge funds?
No. The same test works for private equity, credit and real estate managers.
Should strong returns override weak fit?
Usually not. Strong returns with weak fit are often luck or a single bet.
Who writes the summary paragraph?
The lead staff member or OCIO analyst, reviewed before it reaches the committee.
Sources
- The Single Family Office, Chapter 10, Richard C. Wilson .
More on manager selection and diligence
- How Endowment Staff Read a Fund One-Pager in Ten Minutes
- The Onsite Visit and the Discipline to Walk Away
- Working Through a Due Diligence Questionnaire as an Endowment
- Chasing Performance and Mean Reversion in Endowment Portfolios
- Consistent Performance Measurement for Endowments
- The Downside Math Every Endowment Committee Should Know
