Archive for November, 2017

Evaluating and Selecting Active Investment Managers Based on Skill

Posted by Emmett Maguire III, CFA®

What Makes an Active Manager Skilled

It’s easy to recognize skill. When an individual does something well, whether it be playing golf or knowing all the answers on Jeopardy, you can see they are skilled.

The deeper question is what defines their skill? What makes them so effective on the golf course? And how does the assessment of their skill change when you add or subtract other skilled individuals from the equation?

When it comes to building a portfolio using active management, skill plays a big role. In my last article, I discussed how success in selecting active investment managers is rooted in three conditions; one of which was good “fishing holes”, or identifying the markets with the most opportunity.

Doing so requires skill–but identifying that skill means understanding it first.

The Two Types of Skill

At Lake Street Advisors, the definition of skill starts with a distinction between absolute skill (examination of skill in isolation) and relative skill (examination of skill in relation to others). It would be hard to argue that Jon Lester, the former Red Sox and current Cubs lefthander, is not exceptionally talented when it comes to throwing a baseball. Absent other information, the casual fan would probably recognize him as an MLB pitcher, acknowledge that it’s a rare achievement, and agree he is a very skilled pitcher. This is assessing skill in isolation.

Now, if you were building a pitching staff for an MLB team, it’s highly unlikely you would evaluate talent in this way. Your objective would be to assemble the best pitching staff from the pool of available pitchers to achieve the lowest possible ERA (or whatever your favorite pitching sabermetric may be). To do this, you’d have to make an evaluation on a relative basis. Based on the 2017 regular season, who was the better pitcher, Clayton Kershaw (2.31 ERA) or Jon Lester (4.33 ERA), post season aside? The data would indicate Kershaw was the more skilled pitcher, relative to Lester, and thus more valuable to your regular season pitching staff.

Applying Relative Skill to Active Portfolio Management

Assembling a portfolio of active investment managers is not all that different from building a pitching staff. It’s an assessment of the available options by evaluating relative skill.

The catch is that just like building a pitching staff, it’s not enough to look at a single data point as proof of skill. Just like looking only at past ERAs isn’t going to be the only considerederation when building a strong rotation, you cannot look only at what a manager has produced for returns.

You have to build conviction by understanding where the performance came from. As a savvy GM would evaluate velocity, movement, and command (the qualitative characteristics that produce low ERAs and make one pitcher better than another), manager selection should isolate and examine the aspects of an active manager that offer opportunities for a competitive edge, and subsequently lead to attractive returns over a long time horizon.

The Skill to Effectively Assess Active Managers

Ultimately, the work of active investment managers can be distilled down into the following broad categories:

Whether and how a manager chooses to execute on these categories and the resources used impacts their performance, and represents a potential opportunity to gain on the competition. Or, in other words, improve their relative skill.

Focusing on the “how” and “why” behind these broad categories sheds light on the repeatability of a manager’s process and the amount of effort expended in it’s overall design. Repeatability and deliberate design are not only desirable characteristics in isolation, but also improve insight into how a portfolio manager thinks and what their intrinsic motivations are.

If you are invested in an active manager because their returns for the past five years have been attractive, what are you going to do when they hit a pocket of underperformance? Without an understanding of how a strategy works and a thesis for why you are invested, how will you know if it’s time to sell or add?

To maintain conviction in a recommended active manager and ride out the ebbs and flows of performance over the long term, investors should focus on the manager’s competitive advantages and if they still exist.

By combining an emphasis on good fishing holes with attention to the skill that we believe offers a competitive edge, we gain conviction in our recommended managers–conviction we may not attain if we focus too heavily on performance.

Don’t Feel Taxed this Holiday Season

Posted by Melissa Olszak, CFP®, CFA®

4 Financial Planning Opportunities to Consider Before 2018

As we roll back the clocks and look forward to the holiday season, it’s important to give some thought to year-end financial planning to be sure that any opportunities that expire at year-end are addressed in time to execute them before toasting the New Year.

Here are 4 financial planning items to consider as we approach 2018:


  1. Year-End Giving

You may be considering giving financially, either to a charitable cause or to family and friends. Monetary giving is always a great way to give back or make an impact; however, each method of giving carries different considerations.

If you’re considering giving appreciated securities instead of cash, keep in mind they should be long-term to get the deduction at fair market value rather than at cost.

It may not make sense to make the donation in 2017 if you have already hit the adjusted gross income (AGI) limit for donations and have carryovers from prior years that should be used.

It may also not make sense to make the donation in 2017 if you expect to be in a higher tax bracket next year, as waiting a year may provide you with a larger deduction.


  1. Deductions

Outside of any deductions for charitable giving, there are other deductions you should consider taking before year-end, rather than in the New Year. These include expenses you can take as itemized deductions, such as:

When making the decision to take deductions, it’s important to understand whether you expect to be in a lower tax bracket this year or next, and whether you will be subject to the alternative minimum tax (AMT). If you will be subject to the AMT, you may not get the benefit of the deduction. Therefore, frontloading it won’t help.

The tax system and phase-outs on deductions is complex, and if you’re unsure how deductions can work for you, it may make sense to have your accountant run a current-year projection with (and without) certain deductions. This projection will also help catch any expiring carryforwards about which you may not have been aware.


  1. Investment items

Before the end of the year, it’s a good idea to review your investments to see what opportunities exist. A few to keep in mind are the following:

If you’re unsure whether the securities you are considering are different enough, you should consult with your accountant.

Similarly, if you are planning to purchase, it may be beneficial to purchase after the ex-dividend date to avoid possibly being taxed at ordinary rates on an immediate distribution.


  1. Required Distributions

There are a handful of entities that have required minimum distributions (RMDs), and typically the RMD is measured on a tax year. Here are a few examples you’ll want to consider:

Since many of the above items have several steps involved for execution after a decision is made, it is best to start early. Hopefully by starting early, you’ll be able to enjoy the holiday season and not be feeling taxed by the chase for final deductions, write-offs or other requirements in the final week of the year!