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Investment Approach

Step Four

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Investment Approach—Process

Step Four—Identify and Hire Money Managers

After an appropriate asset allocation is established we select managers and investments within each of the asset classes. Merchants Trust has chosen not to directly employ portfolio managers. Hiring independent managers provides us with the objectivity and flexibility necessary to always act in our clients’ best interest. Our independent research partner, Litman/Gregory, plays a key role in this process, conducting extensive due diligence to identify the most talented mutual fund managers.

We provide two alternatives approaches for the investments within the selected asset classes:

1) Active Management

With active managers we attempt to add value in two ways: Through tactical changes among asset classes and by hiring active mutual fund managers within each of the asset classes with the objective of generating returns that exceed a passive index.

Our asset allocation targets are met using investment managers whom we are confident will beat a comparable index over the long-term. Our manager selection process involves extremely thorough due diligence on the management team, investment process, company culture, and performance results. Our selection process includes the following steps:

We apply quantitative screens (such as performance, fees, asset levels and manager tenure) to narrow the very large universe of investment managers to a subset meriting further research.
We conduct extensive qualitative due diligence, including an in-depth questionnaire, a site visit and numerous personal interviews with the manager, team, and analysts.
We hire only a small number of managers in each asset class who we have determined possess an investment process with an identifiable and sustainable competitive edge.

We believe that only when significant resources are allocated to a disciplined process as that outlined above, can one expect to generate returns that exceed the market indices.

While we are able to employ either a passive or active approach, we recommend the use of active managers for most of our clients. We believe that the depth and quality of our research and due diligence process provides an edge that can identify active managers who will outperform the market indices over time.

A drawback of the use of active managers is that there will be periods of time when they under perform the market index. This is a result of their investing in a manner that differs from the index—which is required to outperform over the long-term. In fact the majority of the managers who have been able to outperform over the long-term did so with extended periods of underperformance along the way.

Money Manager Performance [chart]

One of the biggest challenges of using active managers is knowing when periods of underperformance can be expected to turn around and warrant holding and when to sell. Making the right decision requires an in-depth understanding of what is driving performance. We spend significant time and resources getting to know a manager’s investment approach and defining the “edge” that we believe will enable our recommended funds to outperform over the long term. The managers and analysts for these funds have to make their process transparent for us to do this. The advantage (both for them and us) is that we should be able to distinguish between times when the market environment doesn’t favor a team’s edge and times when that edge has disappeared due to inconsistency, a lack of discipline or various other reasons.

2) Passive Management

While we recommend the use of active managers for most of our clients, we are able to use our tactical asset allocation process with passive funds. With this approach, we attempt to add value over a strategic asset allocation through the use of tactical changes among asset classes. We do not attempt to add value through active security selection. With this approach we focus on the use of index funds and exchange traded funds (ETFs) within each of the asset classes. The objective of these funds is to match the returns of the asset class they are representing.

This approach may be appropriate for the following investors:

Investors who believe there is a low probability of performing better than a market index by selecting investments that differ from the index. They are willing to accept the investment returns generated by the various market indices.
Tax-sensitive individuals who want to use all means available to minimize taxable income while still investing in a diversified portfolio.
Fee-sensitive individuals who want to minimize overall investment expenses. The expense ratios for passive investments are generally less than 0.25%, significantly lower than fees of active managers.
Investors looking for predictable relative returns— while the returns will fluctuate in line with the markets in which they invest, performance of index funds will never lag the index by a significant amount.