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Adding Value through Manager Selection

Although selecting good managers is the first thing most investors think of when talking about adding value, the sad fact is that in almost all cases managers will subtract value from the portfolio. I have devoted an entire chapter to the subject (and the perils) of the manager selection process, so I won't repeat that here.² Instead, let's simply assume that selecting managers who will outperform net of all costs in the future, while they are managing our capital (rather than in the past, when they weren't), is extraordinarily difficult.

So how can manager selection add value? First, select your managers with care. Although it's very difficult to identify managers who will outperform, it's not so difficult to identify managers who are extremely competent, reasonably priced, and who invest in predictable ways.

Second, adopt a skeptical attitude. Unless you are very certain that a manager will add value, your default position should be to index. I don't necessarily mean index in the Vanguard S&P 500 Index Fund sense, because capitalization-weighted indexes present serious issues. But passive and structured products should always represent the default option.

Third, try not to think about individual managers as representing permanent positions in your portfolio. Instead, think about managers as arrows in your quiver of value-adding techniques that can be used opportunistically, as appropriate. For example, consider the case of a manager who ...