Let’s say you are selecting an investment manager.  If you have the relative luxury of having them come to you to explain their investment philosophy and processes, one organizational structure stands out as the most common.  It has analysts who research the ideas, portfolio managers who make the decisions, and traders who execute the orders — essentially the same roles that have existed for decades.

There are all sorts of permutations and combinations, with some investment professionals with other labels thrown into the mix, but that is the basic structure.  Those marketing asset management services are largely in the business of selling experience, expertise, performance, and whatever unique spin on investment philosophy and process that a firm might have.  But there often doesn’t appear to be much difference among the contenders, which is why the selection process frequently hinges on performance and personality.

So, firms that have large and experienced research departments try to differentiate their firm on that basis.  If research is foundational to the process, then their clients are buying an organization, not a star manager.  (Those looking for a star might go through the motions, but they’ll select the star’s firm almost no matter what else might be off kilter.)  Therefore, the research department can be a marketing asset as well as an investment one.

Creating a stable and capable research department is no easy task.  Most analysts want to be portfolio managers, not career analysts.  They either move on to portfolio management or on to another firm, creating a built-in turnover issue, especially for smaller firms.  Life as an analyst at a buy-side shop can be tough:  You have a lot of bosses (the different portfolio managers), you get second-guessed quite a bit, others get the glory for your good ideas, and you get the blame for the stinkers.  The status is less than that of a portfolio manager and so is the pay.

Firms sometimes offer loftier titles and better compensation, especially to key analysts that can make a difference.  In addition, though, analysts like to see that their ideas are recognized and used.  Whether that happens depends largely on the culture of the organization (and whether the commitment to research is lip service or fact).

One vehicle that has the potential to address many of these issues is an analyst-run fund, where analyst ideas are on display more directly.  Conceptually, they provide analysts with a direct outlet for their ideas, without the filter of a portfolio manager (although there are usually constraints of one kind or another).  They can also serve as advertisements for the organization, showcasing the power of the research department and the extent to which the firm has created a framework for highlighting the work of analysts and giving them an outlet for their ideas that doesn’t rely on the results of their salesmanship to others.

A recent article in Morningstar took a look at the analyst-run funds of five major investment organizations, and yesterday’s edition of research puzzle pixresearch puzzle pix | The current pix always appears at the bottom of the sidebar to your right (unless you’re reading this via RSS).  This is the permalink to the posting referenced. featured the performance of them since the beginning of 1996.  However, because of changes in all of the funds over time, it’s hard to draw conclusions about what approaches have worked and what firms have had success in this niche (if any have).

No matter.  We’ll press on, and in the next posting we’ll look at some of the issues involved in taking investment ideas directly from analysts and making a portfolio of them.the research puzzle | That posting, “wagging the dog,” is now available.