James Daley has over a decade’s worth of experience in the investment industry, predominantly in fund research. He is part of the fund selection team within the multi-asset group of DWS, formerly Deutsche Asset Management, where he and one other colleague set up the fund research capabilities from scratch. Prior to joining Deutsche Bank, James was the investment team leader at a regional wealth management firm, covering fund selection and asset allocation.
What do you think leads to success in the fund industry? Can you give some advice for people starting a career in asset management?
In an industry where there can be a great deal of noise, my advice would be to develop a good base knowledge of the drivers of fund performance. This can start with the CFA qualification, though should also encompass reading through the academic literature. This has helped us to focus on what we think are the most desirable traits for funds to exhibit. There are many things to consider when selecting funds, though these traits are always a focal point of our research.
For us, it’s all about looking for the proven ways in which we can increase our odds of selecting successful funds. This is how we think about fund selection – how can we tilt the odds further in our favour. I see this as one of the biggest contributors to the success we’ve had over the years in adding alpha through selection.
Which aspects do you consider most important when selecting a fund for a portfolio?
As previously mentioned there is a range of desirable traits which we look for. Just some of those include high active share, low fees, conservative and stable turnover, the longevity of portfolio management team, alignment of interests within the team, and total assets managed compared to the strategic capacity constraints.
We accept that we won’t always be able to select funds in each asset class that ticks every box, so the judgment comes in knowing where to compromise. For example, we would rarely compromise in risk management, given that this could have the potential to overwhelm the positive attributes.
Understanding the historical performance too is important. Whilst we’re all familiar with the disclaimers, and rightly so, the clues you can collect from interrogating the historical record do help to guide expectations about the circumstances in which future outperformance is most likely to be delivered.
What are the greatest challenges as a fund selector in ESG Investing?
The key principles of selection are the same whether finding an ESG fund or a broad non-ESG fund. Though of course with ESG selection there are a few more obstacles! Understanding how ESG is integrated into the process should revolve around the practical implications on the portfolio, in order to cut through to the true extent of the integration. When it comes to voting and engagement, my preference is not to veer towards those few examples that look great, instead preferring to see the reporting of the voting and engagement throughout the year and understand the approach on aggregate.
As is usually the case, a combination of the qualitative and quantitative provides a more complete picture. We are lucky at DWS to have our proprietary ESG Engine, a powerful tool which aggregates many data providers. In addition to identifying the positive and negative aspects of a portfolio, we are able to interrogate the results to see the individual securities which most impact the scores. The securities which rate poorly within the funds usually provide the most interesting talking points with the portfolio managers.
In addition to these fund-specifics, assessing the firm itself can be important. This includes understanding the broad commitment of the firm to ESG, assessing the in-house expertise, and seeing how the PRI scores have evolved over the years. We want to be selecting best-in-class ESG funds from best-in-class ESG firms.
Beyond the initial selection, there are also monitoring implications. We’re conscious of not introducing significant biases that can come with ESG investing, for example through styles or sectors. Though these cannot always be completely avoided, in which case it’s important we monitor how influential these biases are on the performance, in addition to tracking against both ESG and broad benchmarks.
Taking into consideration ESG Investing and the current market situation, what is your advice to investors?
There has been lots of credible research about the outperformance of ESG funds over their broader alternatives, and whilst the extent of this has no doubt been influenced by the style and sector biases, there does seem to be genuine ‘ESG alpha’. Though my hope is that this does not become the only (or even most important) reason for embracing ESG investing. As an industry, we have the opportunity to lead the way, which includes reflecting on how our investing impacts the world and how we can contribute to solving some of the major challenges we face. So my advice is to have realistic performance expectations, whilst seeing ESG investing as a long-term element of our roles.
How do you decide whether to use active or passive funds?
This is another example of how we try to tilt the odds in our favour of selecting outperforming funds, by focusing on those asset classes where active management has been shown historically to achieve a higher degree of success. If an asset class is particularly hard to find consistent outperformers then we will generally recommend that our multi-asset PMs allocate with an ETF instead, whereby we also provide this selection.
The mechanism by which we do this is our annual active vs passive analysis. This process takes a huge amount of historical data from the bottom-up fund level, allowing us to interrogate the success versus benchmarks from a number of different angles. This includes the success rate of outperformers, the extent of outperformance and the consistency in which this has been achieved by the same funds. We then explore these aspects across asset classes and versus prior analysis.
This has been shown to be a successful contributor to our selection year after year, guiding our research towards asset classes with greater alpha potential.
What kind of adjustments have you made in your portfolio management or fund lists so far in 2021?
As long-term investors, we look for funds to outperform throughout the full market cycle. Style biases are often part and parcel of most funds, so we accept this as long as they are not excessive and don’t overwhelm the investment case. This has meant that in addition to delivering strong alpha in 2020, we have also been well-positioned for the style rotation we’ve seen over the past six months or so.
Looking forward to how the fund lists may develop, aside from continuing to pay close attention to ESG, we see thematics as an area that has the potential to help overcome the challenge of lower long-term expected equity returns. Our focus on the research capabilities of the thematic active fund or ETF are a key driver in how diversified these exposures will be versus traditional indices.