Thursday, 28 August 2014
Last updated 1 hour ago
Jan 18 2011 | 3:13pm ET
There are many risks associated with investing, but the biggest risk of all, according to Hal Daughdrill, chairman of Southeast-based wealth management and advisory firm Diversified Trust Company, is a big ego. It’s one of the reasons why face-to-face interviews matter to Daughdrill, who worked for many years as CEO of a family office and who spoke with FINalternatives’ Mary Campbell from snowy Atlanta about the factors his firm considers when evaluating a fund manager.
First, can you tell me something about your own background?
Well, I spent some time at Goldman Sachs, I was in the institutional fixed income division at Goldman Sachs for eight years. I left there to manage a family office that had land and timber holdings, oil and gas interests, financial assets, private equity interests, as well as a family foundation. I did that for 16 years. Along the way, I was one of the founders of Diversified Trust and although I never worked for the company, I served as chair of its board from its inception [and] for the first 10 years of its life, at which point the outside shareholders sold to the inside shareholders (it became 100% employee owned) and I stepped off the board. But [I] joined it fulltime three-and-a-half years ago, again as chairman, but this time from the inside. So that’s my background, primarily on the investment side, but also in the family office world.
Which is what I’d like to talk to you about—what factors does a family office consider when looking at a fund manager?
I think they should primarily consider three things—people, process and structure. Let’s talk about each of those three. As far as the people go, you know, the hedge fund world is like most businesses, it ultimately gets down to a judgement about people. So we spend a good bit of time looking at the credentials and experience and reputation of the people involved, but [we] primarily make an assessment of what I call ‘ego risk.’ I think of all the risks involved in investing—with interest rate risk and market risk and all kinds of risk—ego risk can bite you worse than any. And it can take many forms—from managers who talk incessantly about the sports team they just bought, the airplane or a second home, or if their offices are just over-the-top and opulent, those are signs that we’re probably not going to hang around too long.
[Laughs] Red flags, exactly. So again, it is making a judgement about people: how they react when things aren’t going their way, those kinds of things.
That’s interesting because it sounds like it’s not even so much about track record as looking at how a manager deals with his success—or lack thereof.
Exactly. It has nothing to do with performance, and I think it can matter a good deal more than performance. It’s how people deal with their own success. Because most of the managers you want to deal with are very successful by definition, but they handle that differently. So, if someone is 50 years old and could have retired 10 years ago but they’re still working very hard, I like that. If they’re 30 years old, I’ve invested with people that age, you really don’t know how they’re going to handle their own success. Again, it’s just a judgement about people.
So that’s the ‘people’ factor, what about process?
Process encompasses a lot of things—and I’m coming at it mostly from the hedge fund side when I say this—I think there are two skills required to be a really great hedge fund manager. One has to do with stock selection or securities selection, so I spend some time with these folks finding out who is doing that, is it a committee? Is it one person? Is it a team of people? The other skill that’s required is portfolio management and that has to do with sizing positions, when to get in and out of the market, managing your gross and net positions. And those are mutually exclusive skills—some people are very good at one or the other, and in my experience, I think it’s rare to find someone who is very good at both; and when you find one, I think that could be someone you could be invested with for a long time.
Process also has to do with their whole investment process—is it a bottom-up process? Top-down? Is it purely quantitative? Do they use a ‘black box’ or not? …How are their people are compensated? Does that promote a team atmosphere or not? [And then] all the operational issues. After that, analyzing performance is very important…but, you know, as far as I’m concerned, in picking a manager, performance is probably down the list of things that matter most. Certainly we want our managers to perform, but there are a lot of things that are as important or more important on the front end.
And so that leaves structure. How important is it?
Also vitally important. How much of the manager’s own money is invested right alongside of ours? Is that a meaningful amount for him or her? Who owns the general partnership of their firm? How long is their initial lockup period, if any? What are their liquidity provisions? And one that’s really come to the fore lately is the extent to which they make less-liquid investments or even private equity investments and therefore, do they have side pockets or not. Use of leverage is important…And then, looking at third-party providers, who’s their law firm, who’s their audit firm, do they have a third-party administrator or third-party custodian? So, that’s a long list, but again, I think everything kind of comes back at the end of the day to a judgement about people and you learn a lot about them when you’re analyzing all those other things.
Has interest in the administrative/operations side of the business increased in the wake of the Madoff scandal?
No question about it. I think it has become foremost in most investors’ minds and therefore I think these firms are getting asked a lot of questions these days about third-party administrators and third-party custodians.
Okay, and on a somewhat different topic, I also wanted to ask you, given that your Diversified Trust office is located in Atlanta, whether you felt geographical centers—like New York—were still necessary when it comes to finance? What’s your take on that?
Well, in a lot of ways, I think it’s an advantage not to be in a financial center. It makes us, perhaps, a little more objective about things. Having said that, I spend a lot of my time in places like New York, that’s where the managers are and that’s where things are happening. But to get out of that environment and to be able to sit back and think about things objectively can be a real advantage. So, we have to travel a little more because there’s no substitute for face-to-face meetings—we would never hire a manager without face-to-face meetings—but we also think it keeps you from moving with the herd.
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