Every industry has its lingo, its jargon, and its favorite phrases. In the investment world, you can see that in spades, even though the words sometimes don’t enlighten as you would expect.
For example, think of the terms that have come to be used to label an asset category — like “hedge funds” or “smart beta” — without really describing the category accurately at all. If you need air quotes and repeated clarifications when using the terms, perhaps we could come up with something better, but those ones have stuck.
Language is a function of the culture that spawns it, so it’s interesting to watch it develop over time and to see what phrases become an inescapable part of the dialogue (even as they become relatively meaningless through repetition and sloppy application). Today’s example: “high conviction.”
If you read the materials of organizations that are involved in investment manager selection, you can’t escape the overuse of the term. It’s ever-present these days. The same is true in investment publications.
As a case in point, the latest issue of Pensions & Investments contained a special report on subadvisors (those firms that are chosen to manage all or part of a mutual fund or other vehicle on behalf of the organization that sponsors it). An articlePensions & Investments | It highlighted the key trends among those firms that manage the most in subadvised assets. in the report left no doubt about what the hot commodity is.
While reasonable cost and manager responsiveness were mentioned as selection factors, over and over the article documents the attraction to “high conviction managers.” So what are they? Well, they are kind of in the eye of the beholder.
The article indicates that firms are looking for subadvisors that bring “a distinct component to their risk-return profile.” Is that it, a statistical fit? Or something else?
Whatever it is, people want it, as BNY confirmed: “We’ve seen growth in our higher-conviction strategies.” After all, as the article notes, “high-conviction investing is a specialized skill.”
Yes, but what is it?!?
I’ve asked that question of those who bandy the term about. Sometimes they struggle with the answer, having to defend a pet description without having a very good way of doing so.
One explanation is that such managers have a higher “active share,” that is, they don’t hug their benchmark indexes but take more active bets. In other cases, people use the term to signify a more concentrated portfolio (which would be high in active share, but some strategies that are high in active share aren’t particularly concentrated). Longer holding periods fit into the definition for some, but not others.
Summarizing, for those who apply the phrase, high conviction investing appears to equal real active management. No imposters, just true blue asset managers that make hard decisions in a difficult world and live with the consequences. (It is a sad commentary that such managers are somehow thought to be rare.)
OK, but the next time an allocator says that they only hire high conviction managers, walk through the portfolio with them and ask what makes each of those managers a high conviction manager. My prediction is the answers will get a bit squishy as you go down the list and the definition will look more and more imprecise.
I’ve even seen a double layer of high conviction proclaimed by some. Not only do the asset managers that are selected have high conviction but the allocator does too! There’s a lot of conviction being thrown around.
At this point, we should probably take a break to look at the behavioral finance literature about the relationship between confidence in our decision making abilities and our actual abilities. Is it conviction we are looking for? The evidence shows that a surplus of that is not always a good thing. Or is it really just concentration? Then we can think about the trade-offs involved with that. Is it something else?
Like other phrases before it, “high conviction” has become a hollow marketing construct. When people toss it around, it’s time to ask some questions to find out what they really mean and whether the name denotes anything special at all.
FYI, my speech on “Rethinking Due Diligence and Manager Selection” has been published by CFA Institute.CFA Institute | The speech was given at the organization’s wealth management conference earlier this year and appears in its Conference Proceedings Quarterly.