Hedge fund management skill - all about process

“We ask a fund manager: ‘How do you define skill?’” says Evans. “For the majority, ‘the return’ is the answer. We ask: ‘Is it something you can control?’ most fund managers say ‘yes’—but it isn’t. The return is the outcome. The skill is the process. Fund managers get themselves into knots with this question.”

“Uncoachable” Underperformance, egos, and asset management’s most obvious structural flaw

Buried in a longer article is a very useful quote and perhaps one of the more insight comments on hedge fund managers and due diligence. You cannot control the results. You can only control the process. I am sure you have heard the same thing with reference to great athletes and teams. Teams cannot control the outcome of the game, but they can control their preparation and the process for getting ready. A great runner cannot control the outcome of the race, but they can control their running style. They often win by following a plan. Plans change but there is even a process for dealing with change.

Managers have the same structure for success. You prepare and do the homework. You do all of the research to generate or measure the odds of success, but you cannot control the outcome. That is uncertain under the actual event. You can have odds in your favor but when the event is realized it may not turn-out according to the expected value. However, by having a process which creates favorable odds, the manager can great a success track record. 

Process is everything. Asking about the track record is easy. A good analysis of the track record is harder, but the purpose of the analysis is just to see how the process matches the results. The track record can tell you something about the success of the process and offers a chance for discussing how feedback is incorporated into the process. It is not definitive. Certainly the sample size of performance in most cases is not large enough to differentiate across managers. It is process that matters. 

We have written about this issue in many of our blog posts on decisions-making. Take a closer look at  my postings because this is a recurring theme.