Tennis fan Tim Clift is used to reading spin both on and off the court.
During a match this can involve adjusting to a devilish slice or sprinting to reach a sly drop shot.
In his professional life, as chief investment strategist for turnkey asset management platform Envestnet, this means cutting through the marketing junk and finding out the truth about portfolio managers.
‘When you’re meeting with an asset manager, they put a lot of spin on their products,’ he says. ‘We train our analysts to cut through the spin and get right to the meat of what we’re interested in finding out, which is the alpha thesis, and if they are able to continue generating excess returns.’
Clift has been in his role since 2011 when Envestnet acquired his old firm FundQuest, which he had joined as a startup back in 1994.
He oversees a team of 36 who build and maintain a platform of strategies used by 52,000 financial advisors who manage $227.21 billion of mutual fund assets.
From the 14,000 strategies on the platform, Clift and a team of analysts then build an approved list and high-conviction select list, which consists of those managers they feel are likely to outperform and generate alpha.
Clift prefers that managers added to the platform have $250 million assets under management at firm level and $50 million at strategy level, along with at least a three-year track record.
The mutual fund high-conviction list is made up of 100 funds, narrowed down from 2,700 mutual funds on the approved list.
Similarly, on the exchange-traded fund (ETF) list, he has two ETFs, which are narrowed down from 123 on the approved list. He also makes a select list for separately managed accounts (SMAs), where 52 are narrowed down from 420 on the approved list.
When assessing funds Clift and his team start with a quantitative approach, which he refers to as the 12-factor process.
The process uses six factors over three-year periods and six over five-year periods. The six factors for each period are comprised of three risk-based factors: active return, information ratio and batting average; and three return-based factors: beta, tracking error and R-squared.
‘We use this process to identify active managers who generate alpha by finding market inefficiencies that they are then able to exploit,’ Clift says. ‘That’s how we are able to distinguish true alpha from luck.’
The quant process aims to evaluate how much of performance is attributable to stock selection versus asset allocation. If security selection is not strong, then there is probably a challenge there, unless the manager is being purchased for their asset allocation, Clift says.
‘If they’re not picking good stocks, you might as well buy an index.’
After the quant process, Clift and his team start digging a bit deeper into the actual managerial team and its experience. He believes most managers – who are able to exploit market inefficiencies – have some kind of edge that lies within their experience or team make-up.
It could be that they have an extensive team, that they are globally based and able to get better information than a smaller firm, or it may even be that they have better risk management tools or a trade advantage.
He uses the high-yield fixed income asset class to explain why size matters. By buying in bulk, managers are able to get better prices and better relationships with trading firms who gain access to an inventory of available bonds which can only be purchased in a larger quantity. Smaller firms may not get the same access, he argues.
‘Boston-based MFS has an edge when it comes to resources,’ he says. ‘Their muni bond team’s deep credit knowledge gives them an information edge over their peers.’
Schechter has been on the fund since 2000 and also manages the $2.1 billion MFS Government Securities fund, the $3.6 billion MFS Municipal High Income fund and the $1.6 billion MFS Municipal Limited Maturity fund.
On the equity side, one of the funds recently added to the select list is the $6.1 billion Causeway International Value fund. It has a large team of eight managers, three of which have been on since inception in 2001, including the firm’s chief executive Sarah Ketterer.
‘I really like firms that specialize, such as Los Angeles-based Causeway,’ Clift says. ‘They only focus on international markets and the depth, strength and pedigree of their team gives them an edge over their competitors.
‘They are also patient to let their ideas work,’ he adds.
Clift says he likes managers who have concentrated portfolios – the average number of holdings per fund on the high-conviction list is 80 – and who consequentially deviate from the index.
One fund he has recently added to the list that exemplifies this is the $4.8 billion ClearBridge Large-Cap Growth fund, which only has 46 holdings.
Although the team is not as big as Clift may have hoped, the fund’s performance more than makes up for it: it is up 34.2% over three years on a total return basis, placing fourth out of 155 funds in its Citywire category, Large-Cap Growth.
For ETFs to make it onto the high-conviction list there is a slightly different process, which is understandably solely quant-based, with a large part of research based on the size of the organization behind the fund.
Clift and his team typically favor ETF firms with over $10 billion in assets and therefore lean to the biggest providers in the market.
‘Fidelity, Schwab and Blackrock have the majority of the assets,’ he says.
Other key aspects are liquidity, costs and tracking error. Each ETF on the platform has to track the index very closely and the more they deviate, the higher chance of being removed from the list, he says.
If liquidity dries up and spreads widen, assets decrease or tracking error spikes, there is a good chance the ETF will be removed from the list, he adds.
Clift says currently more of Envestnet’s advisors use his mutual fund list rather than the ETF version, however, he has seen huge flows into passives over active funds of late.
He puts this down to advisors’ frustration with underperforming managers who have struggled to beat bull markets.
Clift believes the trend for lower fees and the direction of regulation means the popularity of passives will only accelerate.
‘The theme is going to be pressure on costs – so going towards lower costs investment vehicles – that totally favors passive investments,’ he says. ‘That trend has been happening for a number of years now and I think that the Department of Labor rule will only accelerate that phenomenon.’
Whether assessing an active or passive shop, Clift’s time on the court helps him in the conference room.
‘When you’re across the net from someone, you’re always sizing up their strengths and weaknesses, just like an asset manager,’ he says.
‘We spend a lot of time looking at their weaknesses. If I’m playing tennis against someone and I know that their second serve is weak, I’m going to be all over that.
‘If we discover that in an asset manager, compliance controls are weak, or their composite structure is not strong – we’re going to spend a lot of time there.’