Alex Montgomery: Picking an investment manager? Look at the shoes

IN THE early days of 2011 many people are reassessing their investments and considering how and where to commit any available cash for longer term investment.

Sorting through the bewildering array of choices gets harder each year with the number of available funds and investment opportunities on an upward trajectory.

But even so, surely it's easy to pinpoint the truly gifted fund managers who will deliver good returns over the long term from those who have simply hit upon a lucky seam? Let's see.

There has been a noticeable shift in recent years towards the use of pooled funds, such as investment trusts, unit trusts and open-ended investment companies (OEICs) and away from investment in individual company shares.

Two of the main reasons for the shift are the inherent diversification in pooled funds - which helps with the management of risk - and the more attractive tax position that they offer, especially with regard to capital gains tax.

These two reasons alone generally more than compensate for the extra costs that are inevitably involved with pooled investments.

Let's assume that you have spoken to an investment adviser and have agreed an appropriate asset allocation strategy and decided to build a portfolio. You could just take an easy option at this point and choose to invest in passive funds - trackers or exchange traded funds (ETFs).

However, there is clear evidence that in many asset classes the best active managers outperform the relevant index, which suggests that you will sacrifice performance if you take the passive route.

There are certain times when tracker funds and ETFs may be recommended. They can be especially useful in particular situations, say where you are looking for exposure to a particular niche asset class (such as gold, oil or Canadian equities) without wishing to take the additional "manager" risk of significant volatility in returns relative to that asset class.

Assuming you have decided to opt for active funds, your adviser will need to start the process of selection by first determining how much risk a particular fund manager has taken in order to deliver their historic returns over periods of at least three years - and ideally much longer.

This provides a useful chance to scrutinise performance under different market conditions. Complex statistical analysis, built on a substantial historic database, is required to reach meaningful conclusions (as an example, our five-year UK equity fund filter alone currently sifts through 746 funds).

This initial filter is critically important and can be used to develop a shortlist of possible fund managers - but it is not nearly enough on its own.

This is the point at which investors should check that their adviser is pounding the pavements to meet the fund managers face to face.They need to have detailed conversations with the managers which cover a number of topics and which can provide clues as to their skill - or their reliance on a lucky charm.

Questions such as how much of each fund manager's performance is attributable to them personally and how much their team is responsible need to be asked.

What is the lowest cost at which the fund is available? The fund managers need to be probed on how their careers have developed and on their plans for the future.

They need to be grilled on how financially committed they are to their businesses and to their funds. This last question - "do they eat their own cooking?" - is particularly instructive.

Your adviser needs to be able to demonstrate that they have done this (literal) legwork as it's one of the most important ways to separate out those fund managers who have performed well in the past through true skill - and which through the intervention of Lady Luck.

So how hard is it then to sort the skilled fund manager from the lucky? It's actually quite demanding. It takes time, skill and experience to do it really well. You need reams of historical data and the ability to sift through it to extract meaningful knowledge. And all the while the ground shifts under all of our feet, so strategy, asset allocation and fund selection should be reassessed regularly.

But the ultimate test of a good investment adviser? Well-worn shoes.

• Alex Montgomery is partner and head of asset management at Turcan Connell.