The success of multi-strategy absolute return funds comprised of many different strategies has spawned a genre of such vehicles which are becoming ever popular amongst investors, and often feature some of the best brains an investment house has to offer. 
When meeting with the fund managers, however, investors who try to peer into the future often find themselves in a conundrum. Surely they can look at historic attribution, risk/reward metrics, bets and correlations and beta to the equity markets, but they also need to acknowledge that these are all current or backward-looking measures.
The problem is that, given that absolute return funds tend to become unpredictable in very volatile environments and that the financial cycle is already long in the tooth, how does one attempt to predict whether future performance will be as good as the past one?
At Mazars, we have spent some time looking at behavioural factors which may drive markets and funds, as forward-looking indicators. The reasoning is that to assess whether past metrics are relevant to future performance, processes and people need to work as successfully as they did in the past.
We have uncovered four major behavioural factors when assessing the performance of multi-strategy absolute return funds, below.
Groupthink
Social Identity Maintenance Theory states that when group identity is very important to group members (i.e. I am part of the “X” team and this is a very important part of my personal identity), members might think twice before going against the group and offer alternative points of view. This leads to groupthink. High cohesion groups may share more information than low cohesion groups, but tend to insulate themselves from external experts, spend less time and effort assessing that information and ultimately, and maybe counter-intuitively, offer less than optimal solutions (Janis, 1989). Investors must thus ask questions designed to determine group cohesion and look for low cohesion groups that tolerate and in fact encourage dissent.
Directive leaders
Market wisdom dictates that most funds run better with a single manager rather than by committee. Whilst this may hold true for plain vanilla equity or bond funds, more complex strategies require interactions and a multitude of solutions. Research (Flowers 1977) showed that groups with directive leaders shared less information and used fewer facts before reaching decisions. This is actually very intuitive. Investors must make sure that collective-decision funds are not dominated by a single individual. Because all managers will publicly attest to the collectiveness of their process, investors should direct questions to determine where the bulk of decision making powers lie, and most important how many individuals hold a veto. Too man and chaos may ensue. One or two, and directive leadership may overly influence decisions.
Self-esteem
Low self-esteem of group members might make them susceptible to groupthink and direction, stifling independent thought (Janis, 1989). In line with Role Theory, our self-esteem should be enhanced the higher the role we have. A CIO, for example, may be more confident to speak than a junior security analyst. To assess group self-esteem, investors should ask for a list of names, experience and titles of all group members involved in the actual decision-making process. If the list is evenly distributed, low self-esteem maybe less pertinent. If, however, it contains few high powered and experienced roles and many low influence roles, it may be an impediment to truly collective decision making.
Minority influence
Studies are rather conclusive as to the power of majorities to influence decision making. However, minorities, even if their beliefs are not promoted, still have a role to play. Their ideas may influence future decisions (Moscovici 1980). Even if an analyst’s view is not adopted right away, it may come to prominence later. So investors need to understand whether the decision making process allows for everyone to speak their mind and for analysts to be remunerated on their ideas, whether they were followed or not. The latter will ensure that minorities will still be able to influence and augment collective decision making and that their ideas recorded and not forgotten.
It is important to note that all the aforementioned studies are prominent but none of them are mathematically definitive. Behaviours may diverge and not all funds may not fit these principles. They are, however, very useful as a framework, when we are striving to forecast a group’s future ability to continue to come up with and implement good ideas for their investors.
George Lagarias is senior economist at Mazars Wealth Management. The views expressed above are his own and should not be taken as investment advice.