By Jack Forehand (@practicalquant)
It was a cold October day in 2016. I woke up at 3 AM to fly to see the biggest institutional client we had in our investment management business. We had jointly launched two funds with them in 2007 with a small seed investment they provided. Their head of new products had been a subscriber to our research website and had the idea to develop funds based on the quantitative strategies we run. They seeded the two funds with a few million dollars each and we started what became a great partnership. As time passed, the funds grew. Assets steadily rose and performance was good. By that day in October, the funds had grown to $900 million in assets.
So when I got on the plane that morning, I was feeling good about spending the day talking about how we would continue to grow the funds and solidifying what had been a great partnership. As you can probably imagine based on the title of this article, it didn’t turn out that way.
The seeds for our demise were not planted that day, though. The wheels began turning long before that. As I mentioned before, our role as a sub-advisor for this institution had been based on our personal relationship with them. We are a small firm. Our employees are located in different states and we have always operated virtually. The partners we initially worked with at the institution knew that. It wasn’t an issue for them. But over time those people we initially worked with moved on to new things. Some moved to new roles at the same firm. Others moved to different companies. In their place, the firm put in a more traditional manager
Our demise started the year before our trip in October 2016. 2015 was the first year their new team was in place. We traveled to visit them for our annual meeting and had nothing but a positive experience. They had removed many of the other outside managers they used, but we were reassured that we were a big part of their long-term plan. Our funds were performing well and were growing and all seemed well. They also mentioned that they would be sending a member of their new manager due diligence team to visit us the following Spring.
I can still remember that day in May 2016 when they came to visit us. We chose my house as the meeting location. I didn’t know it at the time, but the main competition for our mandate would be one of the largest money managers in the world. They brought them to their fancy offices. We brought them to my house. We didn’t stand a chance.
We spent the day reviewing our investment process. We talked about how we manage money. We talked about the performance of our strategies, which was very good long-term, but had struggled recently along with the struggles of small-cap value. When the day was over, we felt good about how things went.
We didn’t hear from them again until that day in October.
When we arrived at their headquarters that day, the reception was the exact opposite of that previous year. Instead of their senior management coming out to greet us, we were thrown right into a due diligence meeting. Instead of being taken to lunch, we were sent off on our own. It was clear something was wrong. When we got to our final meeting of the day, we found out what it was. I can still remember the exact words: “we are taking a look at your mandate.” When I heard those words, everything made sense. I may not have admitted it at the time, but I knew it was over. Although they didn’t want to tell us at that point, they knew it too. We did everything we could to save it, but a couple of months later the inevitable became reality. We heard words like “lack of infrastructure” and “we want to work with larger firms”, but those were all just ways to say “you’re fired”.
I think everyone’s first reaction in a situation like this is usually a defensive one. You want to think you got a raw deal. You want to think you did everything you could have. That was certainly my reaction in this situation. Our funds had both performed very well in the 9+ years we managed them. We had done everything we were asked. It couldn’t possibly be our fault.
But it was our fault.
When they changed their management team, we hadn’t understood the implications of it. When the funds grew, we hadn’t built the infrastructure that a more formal due diligence team would look for. We didn’t anticipate what the changes in their organization would mean. We also didn’t understand that perception often is indistinguishable from reality. You can have a strong infrastructure and a robust investment process all you want, but if it isn’t perceived that way, it doesn’t matter. Career risk is very real thing in the investment business and if you have to choose between a small virtual firm and one of the largest investment managers in the world, most allocators will pick the latter every time. We may have been ahead of the curve on the virtual thing since I now know several large managers and ETF issuers who are run that way, but that is no excuse.
So I don’t have any anger about the decision. If I was them, I can’t say I wouldn’t have done the same thing. And I still could not have asked for a better career. I have been able to do something I love for coming up on 20 years and have been very fortunate to have some success doing it. We also got to manage this mandate for almost a decade when the average institutional mandate is closer to three years. But the lessons I learned from this experience will always stay with me. Sometimes in life perception is more important than reality. I learned that the hard way.