One of the most important procedures in the investment selection process is to set expectations. While this sounds simple, it is a step that’s commonly ignored by individuals managing their own money, and is often neglected even by investment professionals.
Before buying an investment, it is critical that we establish goals and anticipate performance. Documenting our expectations up front lays the groundwork for a buy-and-sell discipline. Without such a plan, the consequences to your portfolio can be dramatic.

The expectations model we use dictates how we manage our money managers: whom we hire and when we fire. Our method of analysis focuses on five elements, and we ask questions associated with each:

1. Philosophy: What is the investment philosophy of the fund manager? For example, is he or she guided by macroeconomic trends, a value bias, or pure technical analysis?

2. Process: What is the fund manager’s stock selection process? How does he or she make investment decisions, and
what factors are used in determining whether to buy or sell?

3. Performance: How has the fund performed in terms of volatility and returns relative to an appropriate benchmark?

4. People: Who runs the fund, and what is his or her track record? Have important managers recently left or joined the fund?

5. Price: Is the fund reasonably priced, or will expenses cut into returns?

 

By considering these components, we rely on both qualitative and quantitative analysis to arrive at expectations for each fund. This enables us to anticipate and understand performance going forward. We check to ensure that the manager adheres to a consistent process, that fund turnover is low (and, therefore, taxable consequences can be minimized), that cost structure is static, and that the management team is reliable. It is also important that we compare a specific fund with its proper benchmark. Not all benchmarks are created equal, and peer group analysis can be misleading. For one, managers are often entirely unaware of the actions of their peers, and the relationship between a fund and its alleged peer group may be tenuous at best. Moreover, while a benchmark might be well-suited for a particular asset class, it may be inappropriate for any given fund within that class. As an example, the Russell 1000 is a common benchmark used to evaluate large-cap blend funds, but any given fund in that asset class may be competing against the S&P 500 instead. Evaluating performance against an improper benchmark can lead to flawed analysis, and it is not always easy to determine the most appropriate benchmark.

Investments should not be evaluated solely on the basis of absolute performance. An investor might say, “I sold because it was down 8 percent.” But what if the fund’s benchmark were down 20 percent? This concept of return relative to a benchmark is much more important than looking at return in a vacuum. And what if you expected performance to decline in a high interest rate environment, and interest rates had just risen? In other words, while we may often choose to sell an asset if its value drops below a certain threshold, setting absolute rules can be the wrong decision. We should not fire an investment manager only because of poor performance, but, more importantly, because the manager failed to meet our expectations. Moreover, our expectations concern not only return, but also risk. Strong performance can indicate solid management, but it can also indicate higher risk. At the same time, poor performance may represent a good opportunity.

When individuals invest without expectations, they make the investment process complicated and difficult. When do you sell? What explains the fund’s performance? How long has management been in place? Not having expectations also allows emotions to trickle into the investing process, leading people to hold investments for too long when a critical approach would have led them to sell. Before hiring a manager, we make sure to set specific expectations. Intelligent investing requires wisdom from the start. Expectations are necessary for evaluation, and our investment process is incomplete without establishing them.

All indices are unmanaged and investors cannot actually invest directly into an index. Past performance is not indicative of future results. The Russell 1000® Index measures the performance of the 1,000 largest companies in the Russell 3000® Index. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The investment return and principal will fluctuate so that, upon redemption, shares may be worth more or less than their original cost. Investors should consider the investment objectives, risks, charges, and expenses of a fund carefully before investing. The prospectus contains this and other information about the fund and should be read carefully before investing. You can obtain a prospectus from your financial advisor.