Gene Goldman had a riddle on his hands. The numbers were good, but something didn’t quite add up.
‘We visited this manager in Philadelphia and [their] numbers were amazing, really great performance, but they had such a small AUM,’ he says. ‘We tried to figure out why.’
The alarm bells only rang louder when Goldman got down to the stocks. ‘The portfolio manager said they analyze every single company in the Russell 1000 Growth [index], but there were only two people on the investment team,’ he says. ‘That didn’t make sense given the small team size, so I asked the manager what he thought about one of the biggest names in healthcare. He said the stock didn’t make his screen so he didn’t know anything about it.’
Missing assets and a sketchy process – things were looking strange. Goldman’s feelings were confirmed by an onsite visit that suggested not everything was as it appeared. ‘I’m a big believer in the mosaic theory. Basically, it’s about finding little pieces of evidence to make a decision,’ he says. ‘We did a tour of their office, and the person giving the tour was like, “This analyst is traveling, this other person is traveling, this person is out today and this person is on maternity leave.”
‘I looked at every single desk and every keyboard, every calculator, every pen and every notepad. They were all at the exact same angle, like no one was actually working there and they just set it up to make it look like they were there.’
Goldman concluded that no one really worked at the firm. Good numbers be damned – he was out of there, with no plans to invest anytime soon.
Meet the gang
When he’s not sleuthing on the streets of Philadelphia, Goldman can be found in the El Segundo, California headquarters of broker-dealer Cetera Financial Group, where he is chief investment officer and director of research.
He oversees a research group of eight, which is split into three teams: manager research, led by Suehyun Kim; portfolio strategy, led by Hristo Stefanov; and investor strategy, led by Brian Klimke.
Kim’s team spearheads manager analysis, which Stefanov’s team then uses to populate and manage two sets of model portfolios: tactical and strategic. Klimke’s team offers market analysis and views to the group’s 8,000 advisors, who advise on some $224.5 billion in assets. This work is also used to complement manager searches and help in asset allocation positioning in the model portfolios.
‘It really is a team effort,’ Klimke says. ‘Suehyun speaks to a lot of managers, Hristo does a lot of capital market assumptions, and we all kind of come up with the market perspective. That feeds into the asset allocation. Gene is really fun and light-hearted, but at the same time he does work very hard and he’s always the first one in the office.’
The combined teams are responsible for the firm’s research initiative and maintain a high conviction list of 125 active funds from around 40 different asset managers. These are used to populate the models and are also made available to advisors on some of the firm’s platforms. The team does not do due diligence on ETFs, and separately managed account (SMA) due diligence is outsourced to Envestnet.
Looking for clues
While Goldman says there is no fixed criteria for his group to consider adding a fund, assets under management (AUM) and track record are always considered first and foremost.
‘While a fund may have a great long-term track record as an institutional SMA, we need to see a sizable amount of money. When we recommend a fund, we don’t want to own the entire fund,’ Goldman says. ‘Is there a hard rule of thumb? Ideally, for the basic asset classes, it’s maybe $500 million, and for the smaller asset classes, it’s maybe $150 million or $250 million.’
New searches can be prompted by many different things, including a current recommendation closing, meaning that a replacement is needed; a current pick failing the team’s performance-based monitoring process; a particular asset class exhibiting a new investment opportunity; or changes to any of the Cetera models.
Last year, the team had 485 face-to-face meetings and conference calls with managers. Goldman says that he and his team like to use these meetings and calls to ask managers questions that are out of the ordinary in an attempt to dig deeper and push them to justify their responses.
‘If we’re meeting with a large growth manager and they say they really focus on revenue growth… well, we’ve met with a lot of growth managers who focus on cash-flow growth, so we’ll say, “Why not use cash-flow growth?”’ Goldman explains. ‘If they say they’re top-down then we’ll say, “Why aren’t you bottom-up?” If they say they’re concentrated, then we’ll ask, “Why aren’t you diversified?”’
Kim says the team asks these questions to gauge how managers make decisions about their priorities. ‘I want to see that these questions have been thought about, that attention has been paid to the details and that all these things have been considered,’ she says. ‘Not that there’s a right or a wrong answer to each one, but I need to see that the manager has been thoughtful and that they’ve considered these things.’
Not so spooky
While the curious case of the Philadelphia liar is an example of a bad – or perhaps a non-existent – manager meeting, Goldman and the Cetera crew have had plenty of positive experiences too.
One that springs to mind for Goldman is with the management team of the Edgewood Growth fund. ‘We added the Edgewood Growth fund to our list when I came on in late 2011. They had a really tough 2009 and 2010 relative to their peers, and we asked them what happened during that period,’ he says.
‘They explained that one stock was hit hard by a short seller. Afterwards, they incorporated a market dynamic component to their investment process. If they ended up buying a stock and it fell 20% relative to the market, then the stock was taken away from the analyst who brought it to the table and it was given to other analysts who had never seen it to eliminate bias.’
While most gatekeepers are wary of asset managers making changes to their investment process, Goldman is not fazed – as long as changes are made for the right reasons and can be justified. ‘As the world changes, a lot of good managers tend to change how they do things. As long as we can justify, understand and quantify it, then it’s OK,’ he says.
In the case of Edgewood, it proved to be the right call. The fund, which is run by Citywire AAA-rated Alexander Farman-Farmaian, sits top of the 150 funds in the competitive Large-Cap Growth category for three-year total returns.
Those meddling kids!
Before any fund is added to the recommended list, it is voted on by Kim, Stefanov, Klimke and Goldman for final approval. Goldman gets two votes, while Kim, Stefanov, and Klimke each get one.
‘Gene has given us a good amount of freedom so we can contribute ideas. It’s not like there’s a single vote that counts because we have a consensus. I think that consensus has been valuable to our process as well,’ Stefanov says.
At the moment, the team has a preference for larger, established portfolio managers, in part because the team believes these managers will be able to weather the storms facing the asset management industry. Goldman explains that fund companies are facing a lot of pressure on revenue, lower fees and platform rationalization. He believes that the ones with scale will stand a better chance of survival.
‘We want the safety of a larger firm with a bigger infrastructure in place, the ability to pay for larger legal teams, to spend more on portfolio managers and analyst compensation, and to weather the uncertainty going forward,’ Goldman says.
As he discovered once before, the last thing you want is a disappearing manager.
Editor's note: Since this article was first published, Citywire reported that Suehyun Kim is to leave Cetera at the end of June to join Wilshire Associates.