Due Diligence and Manager Selection

How long will you stick with a manager if performance is poor?

There is no hard and fast rule, but our willingness to stick with a stock picker is heavily influenced by our confidence in their skill and enthusiasm for being a part of Litman Gregory Masters Funds. Our regular monitoring keeps us up to date on the manager’s portfolio and the reasons behind good or bad performance. And, based on our contact we are always assessing whether the reasons we hired the sub-advisor in the first place remain valid. However, if for any reason our confidence in the sub-advisor comes into question we will typically do a thorough update of our due diligence.

Are the managers under contract? If not, what is to stop them from walking away?

As is often the case in our industry, the managers are not under long-term contracts. This means that they could walk away or we could fire them at any point. Practically speaking, if the relationship is going well and they are doing a good job, we will want to keep them and they will want to stay. If that is not the case, we wouldn’t want to keep them and we certainly wouldn’t want a sub-advisor to be contractually forced to run money for Litman Gregory Masters Funds.

How do you know you’re getting the sub-advisor’s highest conviction ideas?

There are two ways we can assess this. The objective way is to compare the sub-advisors’ performance for Litman Gregory Masters Funds against other portfolios they run. This is particularly telling if the other portfolios are significantly more diversified. When we hire sub-advisors it is with the objective that they be able to deliver higher long-term returns with their concentrated Litman Gregory Masters Funds portfolio than they would in their more-diversified portfolios.

Is the due diligence process the same when hiring a stock picker for Litman Gregory Masters Funds as it is when selecting a third-party fund Litman Gregory’s affiliates use in client portfolios?

While the basic due diligence process is the same, we will additionally assess the stock picker’s comfort with running a concentrated portfolio and their enthusiasm for being part of Litman Gregory Masters Funds. Our selection criteria for hiring Litman Gregory Masters Funds sub-advisors are the most demanding.

How do you assess whether a stock picker is able to add value by running a concentrated portfolio?

It is easiest to evaluate this if they already have experience and success running a concentrated portfolio. For example, Mason Hawkins and Bill Nygren have both run concentrated funds. For stock pickers who have not run a highly concentrated portfolio, we ask them to put together a “mock” portfolio to reflect the stocks they would hold if they were already running a Litman Gregory Masters Funds portfolio. We then discuss the portfolio so that we can understand the criteria and the process used to identify the highest-conviction ideas and to build the portfolio.

How do you identify sub-advisor candidates?

We have been conducting due diligence on stock pickers since the founding of our firm in 1987, so we are already very familiar with many industry veterans. Also, by being in the industry for many years, we are familiar with many others by reputation. Aside from managers we already know, we also search industry databases and we are often contacted by investment management firms interested in running money for Litman Gregory Masters Funds. Finally, we also query stock pickers we respect for recommendations.