Don’t Look

Back: Five Ways

Investors Can
Select Better
Managers part
3 of 3

How Novus Improves the Investment

Manager Evaluation Process

Stan Altshuller
 L
2 Don’t Look Back: Five Ways Investors Can Select Better Managers / July 2015
arge institutions that hire mon-
ey managers usually perform
multiple levels of due diligence
and manager research before
they invest. While, in theory, it
should not be difficult to hire
managers to run money for you
or your clients, the job has many challenges and
potential pitfalls. Alternative managers like Hedge
Funds have high fees, smaller managers carry
some degree of business risk, while many larger
ones are unable to successfully deploy the capital
they have accumulated. On top of this, managers
and their strategies change with time and those
that performed well in the past are not guaran-
teed to do so in the future. With that in mind,
it's the investor’s job to use all the information
available to them to select the managers who will
perform best on their dime. With all the variables
out there, it’s a bit like trying to predict the future.
While still part art and part science, some new
research methods employed by sophisticated
investors around the world are proving their
value. Based on granular positions data instead
of monthly returns, these methods are better
suited to inform forward-looking decisions than
the traditional tools the industry has relied on.
In part one of the series, we described the
status quo of manager evaluation and argued for
the use of predictive metrics in the institutional
investment process. In part two we discussed
five concrete steps that investors can take to im-
prove their research using monthly risk reports
sent by managers. In this edition, we talk about
the holy grail of analytics: the use of private
positions and P&L data to evaluate managers and
groups of managers in a portfolio. Using posi-
tional transparency, investors can zero in on and
Prediction is very difficult,
especially if it's about the future.
Niels Bohr
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isolate managers’ investment skill, and uncover
red flags otherwise hidden. If taken, the five
steps outlined here can catapult an organization
to the top tier of institutional investors using all
available data to evaluate managers and assess
risk in their own portfolios.
Before we dive in, a quick yet critical note on
data. All investors should ask managers for maxi-
mum transparency, and that means positions with
P&L. Ask your managers for daily positions, and
if you get pushback, ask for them on a lag (30, 45
days?) or a lower frequency (monthly, quarterly?).
There is a point where any manager should be
comfortable with providing transparency to their
investors. The five steps described below assume
that you have secured position-level transparency
from at least a portion of your managers. After-
wards, you'll need to do some data cleaning and
normalization as it rarely comes in usable formats.
When all the data work is done, make these five
steps a part of your investment process and join
the top investors in the world.
1/ Look for security selection skill at a
fundamentally driven L/S manager
2/ Look for position sizing skill from a
good portfolio manager
3/ Look for high win/loss ratios to find
managers who maximize winners
and cut detractors
4/ Look for unique managers with
low overlap if you want diversification
in your portfolio
5/ Look out for red flags like liquidity
decline, over-trading, sharp asset
growth with style drift and poor
exposure management to control for
risk you can’t see with returns analysis
3 Don’t Look Back: Five Ways Investors Can Select Better Managers / July 2015
1/ LOOK FOR SECURITY SELECTION
SKILL AT A FUNDAMENTALLY
DRIVEN L/S MANAGER
Many managers claim to be great stock pickers
and claim to know their companies better than
the street. If that is the case, their investments
should (on average) outperform their relevant
sector benchmarks. Top investors measure their
manager’s security selection skill to see if it
confirms what the manager claims. To measure
this skill, you need to decompose the manager’s
returns into its distinct parts: those that depend
on the market and those that depend on the
manager’s investment process. At Novus we do
Good security selection skill across sectors
Poor security selection skill
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this with something called the Novus Framework,
a method we developed to decompose returns.
Other methods exist and many investors use their
own techniques developed in-house. The point
is always the same: to understand the drivers of
returns, you must look at their components. If
the manager is sector generalist, you want to see
strong selection skill across various different sec-
tors. Hopefully the ones they chose to size up are
the ones with highest skill. Here is an example of
a manager with strong selection skills especially
in Financials, Industrials and Healthcare. The next
chart is a manager showing poor selection skill
across the majority of their sectors, meaning they
would do better in sector ETFs.
4 Don’t Look Back: Five Ways Investors Can Select Better Managers / July 2015
2/ LOOK FOR POSITION
SIZING SKILL FROM A GOOD
PORTFOLIO MANAGER
For some managers stock picking is key, yet for
some others stock-picking does not matter. You
may come across a manager that invests in the
same stocks that every other manager invests in
or simply holds all the stocks in the S&P 500, yet
their ability to properly size positions more than
makes up for lack of stock selection. Much of
our work over the recent years points to position
sizing being one of, if not the, most import-
ant skill an active manager can possess. Many
multi-billion dollar managers owe their success
not to their ability to pick unique stocks but their
Good position sizing
Poor position sizing
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ability to express conviction in just a few stocks
in their portfolio. The analysis is a simple one. To
isolate position sizing skill, compare the actu-
al returns of a manager against a rebalanced,
equally-weighted portfolio. If the actual portfolio
consistently generates alpha, you are looking
at a skilled portfolio manager. The manager we
analyze below is an extreme outlier, they are
one of the best position sizers in our universe. In
contrast, the manager we chose for the following
chart consistently losses money through poor
sizing decisions and would have been much bet-
ter off equally weighting all their positions. Keep
in mind that these are two extremes, the average
position sizing value add of all managers over the
last five years is close to zero.
5 Don’t Look Back: Five Ways Investors Can Select Better Managers / July 2015
3/ LOOK FOR HIGH WIN/LOSS
RATIOS TO FIND MANAGERS
WHO MAXIMIZE WINNERS
AND CUT DETRACTORS
Another important skill in addition to selection
and sizing is getting the most from your winning
trades and limiting your downside from losing
trades. Managers often speak of this concept as
watering your plants and cutting your weeds.
You can quantify this with the win/loss ratio.
The win/loss tells you how much profit the
manager makes when they are right versus how
Good win/loss ratio
Poor win/loss ratio
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much they lose when they are wrong. In the
chart immediately below, the manager reaps
9.8 times more P&L from their winning names
in Telecom than they lose on losing names in
the sector. The next chart shows win/loss ratios
below 1 meaning the manager lost more on the
losers than they made on winners. Our previous
work shows that this particular metric is even
more important than the batting average (how
often a manager is right vs. wrong). Look for a
high win/loss ratio in managers who time their
trade entries and exits well and also make good
sizing decisions.
6 Don’t Look Back: Five Ways Investors Can Select Better Managers / July 2015
4/ LOOK FOR UNIQUE
MANAGERS WITH LOW
OVERLAP IF YOU WANT
DIVERSIFICATION IN
YOUR PORTFOLIO
If your organization is like most of the investors
we work with, you invest in a group of funds and
diversification and sources of unique alpha is
important. Traditional tools like the correlation
matrix rely on past performance, a notoriously
non-predictive data set. Let’s say two manag-
ers had very different portfolios historically but
recently have both entered into many of the same
trades. Correlations might be low even the two
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portfolios are nearly identical. This can happen
without any conversion or collusion on the part of
the mangers, it could simply be a result of a sim-
ilar investment research and screening process.
Our clients rely on an analysis called Overlap to
understand the actual security concentration and
overlap in their portfolios. Below is an example
of Novus Overlap for a prominent group of hedge
fund managers dubbed the Tiger Cubs for their
ties to Julian Robertson’s Tiger Management. You
can see that some portfolios are very unique while
others are heavily overlapped with certain manag-
ers. Clearly, holding two very similar managers in
your portfolio does not offer as much diversifica-
tion benefit as holding more unique mangers.
7 Don’t Look Back: Five Ways Investors Can Select Better Managers / July 2015
5/ LOOK OUT FOR RED FLAGS
LIKE LIQUIDITY DECLINE,
OVER-TRADING, SHARP ASSET
GROWTH WITH STYLE DRIFT AND
POOR EXPOSURE MANAGEMENT
TO CONTROL FOR RISK YOU CAN’T
SEE WITH RETURNS ANALYSIS
Finally, positional transparency is used by the
world’s top investors to track portfolio charac-
teristics such as declining liquidity, increasing
concentration and severe style drift. Recently we
Liquidity Decline along with increase in AUM
volume for each stock in the portfolio.
CONCLUSION
The world of investing is quickly evolving. Alter-
native managers, long deemed black boxes, are
becoming much more transparent and many now
provide positional transparency to their inves-
tors or risk aggregator systems. The world’s most
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discussed the five most common investment mis-
takes managers make and may not even be aware
of. All of them require position level transparen-
cy to identify and correct. The most important
red flag we have seen is a precipitous decline in
liquidity, as you see with a manager in the next
chart.
To calculate the liquidity profile of a manager
we make some assumptions for selling parame-
ters and calculate the percent of portfolio that
the manager could sell in 30 consecutive trading
days. We use the 90-day trailing average of daily
sophisticated institutional investors have figured
out how to use this transparency and many use
Novus to tap directly into the value laden in this
massive data set. The insight you can gleam from
positions is forward looking, unlike returns based
analysis. And the five steps suggested here
should provide a good starting foundation for an
investment process built on positions data.
 8 Don’t Look Back: Five Ways Investors Can Select Better Managers / July 2015 NOVUS

ABOUT THE NOVUS PLATFORM™

ALL YOUR ANALYTICS IN ONE PLACE.

The Novus Platform™ is the world's most advanced portfolio analytics and intelligence platform designed to help
institutional investors consistently genterate higher returns. The platform is used the top hedge funds, fund of
funds, pensions plans, sovereign wealth funds and endowments around the world to analyze risk, performance and
attribution and conduct portfolio research across aggregated and historical data sets. Portfolio managers, investor
relations teams and operations teams use the Novus Platform in different ways, but ultimately to generate more
alpha, analyze and manage their risks, report to their investors and become more efficient with resources.

Data Management order to get an unbiased

Novus automates the data management side of
investing. Our team actively manages all exposure
reports, monthly performance updates, balances &
transactions, quarterly letters, position level extracts
and more on a historical and forward going basis. Novus
scrubs the data, normalizes it so it can be interpreted
across investments, and produces clean historical
datasets for your ready consumption.
Data Aggregation
By centralizing disparate sets of data in one place,
investors can easily view their firm-level, portfoliolevel
and fund-level exposures, performance & attribution,
risk analytics and positions data without the hassle of
building complex systems to track their investments.
Investors can graduate from tangled excel spreadsheets
and internal models that need to be constantly
maintained. Focus on what matters most - research, due
diligence and analytics.
Performance & Attribution
Novus’ performance & attribution tools let investors
easily measure and compare all of their managers
individually, side-by-side and from a top-level
aggregated view across the entire portfolio. Investors
can focus on where their managers are generating alpha
and what strategies are working best in their portfolios.
Using advanced peer-analytics tools, investors can
also compare their manager’s performance against a
universe of hedge funds that employ similar strategies in
understanding of how their existing managers compare
against peers.
Risk Analytics
With a data infrastructure that incorporates exposures,
securities, positions and PnL, investors can quickly
analyze key risk statistics at the fund, portfolio and
firm level across an entire portfolio - all with just a few
clicks. Investors can view their risk exposure by asset-
class, sector and geography or even compare manager’s
side-by-side to better understand the portfolios risk
contributors.
Reporting
Novus reports put a wealth of information at your
fingertips. The platform’s reporting tools support robust
analysis and research that allow users to build insightful
reports for both internal and external consumption.
Whether you’re looking for a simple 1-pager for your
weekly meetings, a more comprehensive report for
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your investors, the Novus Platform’s reporting tool lets
you quickly and easily create manager-level, portfolio-
level or firm-level reports.
• Exposure Reports
• Performance & Portfolio Attribution Reports
• Risk Reports
• Peer Comparison Reports

CONTACT SALES@NOVUS.COM TO LEARN MORE

9 Don’t Look Back: Improving the Investment Manager Evaluation Process / July 2015 NOVUS

For more information, contact:

Stan Altshuller
Co-founder & Chief Research Officer

Mr. Altshuller is Novus’ Chief Research Officer and charged with spearheading various business initiatives, leading the research
team and overseeing blueprinting and competitive analytics for the Novus Platform™. Before co-founding Novus in 2007, Stan
worked in Ivy Asset Management’s Portfolio Management Group as part of a team responsible for constructing, monitoring and
managing all of Ivy’s portfolios. At Ivy, he designed and implemented a set of tools and processes for analyzing multi-manager
portfolios focusing on key drivers and risks across the entire product line. Prior to Ivy, Stan served at Lyster Watson & Co., where
he was responsible for quantitative analysis, manager screening and portfolio modeling. Stan holds a B.S. in Mathematics and a
B.A. in Economics from Brandeis University.

To contact Stan, please email him at: stan@novus.com

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