January 16, 2007

Coping with change
How to respond to manager changes

The second half of last year saw the lead managers of a handful of Canada's largest and most popular funds leave for various reasons. In most cases, advisors and investors were left to make very difficult decisions - i.e. stick with existing fund and new manager; or dump the fund and follow your star? Drawing on past manager changes, however, doesn't give us the answer.

Manager changes and past experience

I classify manager changes in two broad categories: minor and major. Minor manager changes usually involve an individual leaving where he was supported by a portfolio management firm with lots of depth and a strong infrastructure. Templeton is a good example of this type of firm. A major change often involves a manager change on a fund sub-advised by a firm separate from the fund's sponsor (i.e. Talvest Global Health Care fund) or where the individual lead manager is key to a fund's success (i.e. Chou funds).

The recent departure of Kim Shannon's Sionna Investment Managers from CI Canadian Investment Fund (and other funds) is a major manager departure because her firm was a sub-adviser to the CI funds. I classify Alan Radlo's pre-Christmas departure from Fidelity as another major change. This, despite being part of one of the largest money management firms on the planet.

By contrast, I consider the lead manager changes at Templeton Growth Fund Ltd. to be minor because of their management structure. As such, I was unfazed when lead manager roles shifted from Mark Holowesko to Sean Farrington (mid-2000); then to George Morgan (December 2000); and now to Lisa Meyers (September 2006).

See this September 2000 article and this March 2001 column for some history of manager changes.

Tracking past major manager changes and subsequent performance provides a mixed picture of how best to respond to such changes. In some cases, staying with the fund and its new manager has been the best move. In other cases, following your chosen manager yielded the best performance. Here are tips to making such difficult decisions without the benefit of hindsight.

Decision framework

Here is a summary of my four-step process for evaluating manager changes and making a recommendation. To illustrate each step, I will use the 2002 departure of Brandes from, and the subsequent hiring of Harris Associates for, AGF International Value fund.

1. Classify change. As above, it helps to first decide if the change in lead manager is 'major' or 'minor'. If it's minor, your opinion of the fund in question should not change, unless the management firm has lost many investment professionals. If it's a major manager change, then proceed to the next steps. Brandes. departure from AGF was a pretty obvious case of a major manager change.

For other cases - i.e. where an individual leaves but the same management firm continues to manage the fund - you may be left wondering whether the track record of the fund in question belongs to the departing individual manager or the firm that continues to run the fund. Some academic research pegs 70% of past performance as belonging to the organization; while a big bank fund analyst recently commented that nearly all of the past performance belongs to the individual lead manager. From experience, it's too difficult to generalize and such an assessment can only be done on a case-by-case basis.

2. Assess new manager and new product(s) of departing manager. This is a critical step with a focus on three questions: a) is the new manager good; b) how different is the new manager compared to the departed manager; and c) would I recommend the departed manager's new fund(s)?

When AGF selected Harris Associates L.P. to replace departed Brandes, I spent a lot of time becoming familiar with Harris. My basic conclusions on the above points were that I liked Harris (and began recommending them - and still do). But I felt that Harris' style of investing was more similar to Growth-at-a-Reasonable-Price than to Deep-Value. This meant that while the two share some philosophies, they have very different processes and execution styles. Finally, I also continued to recommend Brandes' core mandates.

It's worth noting that advisors and investors may lack the time, access, and/or knowledge to carry out this step the way I do. That notwithstanding, conference calls, fund company material, and any past performance data should help in this regard.

3. Identify your preference. In deciding whether to sit tight or follow the departing manager, a preference between the two must be determined. In the end, this decision will be made with a big dose of subjectivity because the future is inherently uncertain. In the case of Brandes vs. Harris, my June 2002 report on the subject expressed a preference for Brandes.

4. Quantify the costs of selling and make a recommendation. The most common costs of moving are selling fees (i.e. trading costs, redemption charges) and income taxes on realized gains. In the case of AGF International Value, many were frustrated since a big road show preceded Brandes' departure, which kept the sales flowing (much of it on a deferred sales charge). Despite my endorsement of Harris, my advice in 2002 was to follow Brandes so long as the costs of moving were not substantial. Given that the markets were knee-deep in a painful bear market, tax consequences were only an issue for longer-term investors.

I generally don't worry about deferred sales charges if they're under 3% or if the difference in fees alone can recoup any exit fees within a couple of years. As for tax consequences, the year 2000 serves as a painful reminder that investment decisions should not be purely tax-driven. Quantifying the return difference needed to make up the tax bill will help put the situation in perspective, though it's always tough to trigger a tax bill for the possibility of better performance.

Advisors and investors affected by the recent departures of Kim Shannon and Alan Radlo are faced with a difficult task. In the case of CI, a replacement with good long-term performance has been appointed and Shannon's new funds are now for sale at Brandes. In the case of Radlo, he leaves Fidelity which has hundreds of analysts, including its huge Team Canada.

Using this framework will help get you through what are surely very tough decisions and provide consistency to similar evaluations in the future.