How to Evaluate an Active Manager
If the previous piece in this series concluded that a hybrid of passive and selective active is the honest answer for investors with significant wealth, this one is about the harder problem the conclusion creates: how to evaluate the active manager you are considering hiring. The answer is not a database lookup or a track-record screen. It is a small number of direct questions, asked in person, with attention paid to how directly the answers come back.
Six questions are usually enough. They are the same six I would expect any prospective client to ask of me. They will not, by themselves, tell you whether a manager is going to outperform, no question can do that, but they will tell you a great deal about whether the manager is doing what they say they are doing, whether their incentives are aligned with yours, and whether the relationship is structured for transparency or for opacity.
1. How is your money invested?
If a manager runs strategies they recommend to clients, the natural question is whether they invest in those same strategies themselves, on what terms, and in what proportion. A specific answer is more credible than a generic one. "I eat my own cooking" is a slogan. An answer that names the strategy, describes the terms on which the manager participates, and explains how those terms compare to a client's, same securities, same fee structure, same liquidity, is a fact. Listen for whether the answer carries that level of specificity, or whether it stays at the level of slogan.
The answer matters for two reasons. The first is the obvious one: when the manager and the client are exposed to the same outcomes, the manager has a powerful incentive to make decisions the way they would for themselves. The second is more subtle. A manager whose own capital is in the strategy will have lived through every drawdown the strategy has produced. They will not need to imagine what it feels like; they will remember. That memory shapes how they communicate during difficult periods, and how they avoid the kinds of decisions that look defensible in a quarterly report but feel different when they are happening to your own money.
A manager who does not invest in their own strategies should have a clear, specific reason. Some have legitimate ones, concentration in their own firm equity, regulatory restrictions, family circumstances. Others do not. Listen for whether the reason is specific or generic.
2. How will my portfolio be constructed for me specifically?
Two answers are possible to this question, and they describe entirely different businesses.
The first is "from a target allocation" or "from a model." The portfolio you will own is one of a small number of templates the firm offers, sized to your risk profile, populated from an approved list of underlying funds or securities. The work is in the model, not in your portfolio. This is how most of the wealth-management industry is built, and for investors below a certain scale or with simple circumstances it can be entirely appropriate. It is also generic, in the literal sense that the portfolio you receive is substantially similar to the portfolio your equally-circumstanced neighbor receives.
The second is "from individual positions, argued line by line, against your specific situation." The portfolio is built one decision at a time. Each holding earns its place because of something specific about you, your tax circumstances, your concentration elsewhere, your liquidity needs, your willingness to live with active risk in particular categories. The work is in your portfolio, not in a model.
Neither answer is wrong, but the answers are not interchangeable, and a firm that obscures which one it actually delivers should be examined further. Listen for whether the conversation is about your circumstances or about a product the firm has prepared in advance.
3. How are you compensated?
A flat percentage fee on assets under management is the simplest answer and the easiest to evaluate. It scales with the size of your account and creates an incentive for the manager to grow your assets, which generally aligns with your own incentive. It does not eliminate conflicts, the manager still benefits when you add capital and is hurt when you withdraw it, but it is at least transparent.
Other compensation structures are common and not inherently problematic, but they introduce additional layers worth understanding. Performance fees can align incentives further or can encourage excessive risk-taking, depending on the structure. Commissions create incentives to recommend the products that pay them. Sub-fees on underlying funds (a manager charging a wrap fee that sits on top of additional fees inside the funds they recommend) can result in total all-in costs materially higher than the headline. "Complimentary" services, financial planning, estate review, concierge, are paid for somewhere; the question is where.
The most useful version of this question is: "What is the all-in annual cost to me, in dollars, including everything that is paid by anyone to anyone in connection with managing my money?" A manager who can answer that question in dollars, plainly, is a different proposition than one who needs to circle back with a footnote.
4. What is your view on active versus passive?
The honest answer is usually "both, depending on where in the portfolio." An absolute answer one way or the other, given without reference to specific portfolio sleeves, tends to reflect the manager's commercial position more than the underlying analysis.
What is more useful than the headline answer is the reasoning behind it. A manager who can explain, in your specific portfolio, which sleeves are appropriately passive and which are appropriately active, and why each judgment is what it is, is doing the work. A manager who answers in slogans, "we believe in active management" or "we are evidence-based", is signaling the conclusion before showing the analysis.
Listen also for whether the manager is willing to recommend passive in places where their own economics would be better served by active. A manager who proposes index funds for the parts of your portfolio that should be indexed, even though their fee is the same either way, is being honest. A manager who finds active reasons for everything is showing you something.
5. What does your monitoring and reporting look like?
The reporting is where the work either becomes legible to you or stays hidden. It is also where most relationships drift, because monthly statements that are technically accurate can still leave you with no real understanding of what you own and how it is performing.
Worth asking, specifically:
- Will the reporting consolidate everything in one view, or will I be reading multiple statements from multiple custodians and assembling the picture myself?
- Are returns reported net of fees? Of all fees, including underlying fund expenses?
- Are the benchmarks appropriate to the strategy, or is the S&P 500 stapled to a multi-asset portfolio in a way that flatters the comparison in some quarters and damages it in others?
- Will I be able to see, position by position, what I own, why each position is in the portfolio, and what changed in the period?
- How quickly can I get a question answered, and by whom?
Reporting tells you something about how the relationship is structured. A manager who hands you a one-page summary and a manager who gives you a comprehensive view and welcomes interrogation are operating under different assumptions about the client relationship. Both can be honest; the household should choose the structure that fits how it wants to interact with the work.
6. Who decides, you, a committee, or a model?
Many large firms route investment decisions through investment committees, risk frameworks, and approved-product lists that turn what looks like a personal relationship with an adviser into a process you cannot influence. The adviser becomes the front office of an institutional decision machine. That arrangement may be entirely fine for many clients; it should not be hidden.
The question to ask is concrete: when you and your adviser disagree with what the committee or model recommends, what happens? Can the adviser make an exception for your specific circumstances? Or is the recommendation effectively non-negotiable? The answers vary widely across the industry, and the answer for your specific firm matters more than its marketing.
Smaller firms, single-manager firms, and partnerships tend to give the principal you actually meet much more decision-making latitude. Larger firms tend to give them less. Neither is right or wrong as a structure; both can serve clients well. But you should know which one you are buying.
What to do with the answers.
None of these questions has a single correct answer. They are not a test that the manager passes or fails. They are a structured way to see how a manager actually operates beneath the marketing, and to develop, over the course of a single conversation, a much clearer picture of whether what they offer fits what you need.
The pattern that emerges from the six answers is more useful than any single one. A manager who is direct on every question, who names numbers where numbers are warranted, who acknowledges trade-offs in their own approach, and who welcomes the questions rather than tolerating them, is signaling something important about how the relationship will work. A manager who deflects on more than one question, who answers in slogans, who frames every choice as obvious in their own favor, is also signaling something important.
The questions are the same six I would expect any prospective client to ask of me. The right reaction from any manager who is doing serious work is not just to answer them, but to be glad they were asked.
These six questions and what to listen for in each are also in the workbook companion to this series, which adds a few more red-flag patterns to watch for during adviser interviews. Download here.
Alphyn Capital Management, LLC is an investment adviser registered with the U.S. Securities and Exchange Commission. This post is for informational and educational purposes only and does not constitute personalized investment, tax, or legal advice or a recommendation to buy or sell any security. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal. No portion of this article is to be interpreted as a testimonial or endorsement of the firm's investment advisory services. Please consult qualified professionals before making any investment decisions. This post may contain forward-looking statements and represents the author's opinions as of the date of publication. Such statements are inherently uncertain, and actual outcomes may differ materially. ACML does not undertake to update any forward-looking statement.