If you invest at all, the chances that you are invested in a fund are very high. The popularity of ETFs, of which there are now thousands, has brought together active traders and fund managers more than ever, and the structure of funds has changed radically as a result. Yet one thing we haven’t seen is much change in the core jobs within those funds.
Imagine an ETF with an active strategy and $1 billion in assets under management and a 0.5% management fee. That fund is now a business with a $5m run rate, which also means that it is large enough to employ a portfolio manager and two analysts at the very least. And, to be competitive, the fund is going to pay the PM probably several multiples of what the analyst does.
Who will these people be? Both will likely be established asset managers with a background in investment banking, and the PM will be senior to the analyst in age and experience, but the backgrounds will be similar otherwise. The pipeline of investment banker to asset management analyst to asset management portfolio manager is well trodden by generations of Wall Street types, and the career path not only ends with seven and eight-figure compensation annually, but it can go to even larger compensation if many years of compounding returns turn your fund into a superstar.
If you conclude from this that analysts and PMs overlap in responsibilities, interests, and work methods, you’d be wrong. The analyst is typically involved in deeply analyzing individual assets and determining their estimated fair value, and this kind of in-depth fundamentals-driven investing is very familiar to anyone with an interest in capital markets. It is also the kind of research that sell-side analysts frequently produce and provide to clients (examples of sell-side reports and in-depth explanations of both them and buyside research are available at the CFI and widely across the internet).
The principles behind the PM’s job are very different. She is not doing in-depth research on individual companies, but rather collecting the reports her analysts have provided and incorporating them into an asset allocation strategy. In short, the reports her analysts provide her combined with her own work results in a theoretical portfolio optimized for whatever the fund’s goal may be.
She does not do this by using the same methods as her analysts have used to produce their own reports; instead, she will be relying on a stricter and more abstract empirical method of designing a portfolio that meets her needs. To do so she’ll use modern portfolio theory (MPT), which is a collection of ideas and theories to help portfolios become more efficient.
MPT is grounded in statistics and mathematics, but fortunately the math at the core of MPT is quite simple. However, MPT is a rabbit hole, and the academics and PMs who spend their lives in this niche can end up using extremely difficult and complicated mathematics to concoct their portfolios. The math is not as complex as it quantitative analysis and in quant hedge funds, but that is an extremely high bar. In reality, MPT provides a very deep collection of tools and ideas to create a unique approach to asset allocation.
In short, the analyst’s job is to make sure the constituents of the portfolio are the best they could possibly be, while the PM’s job is to make sure the best of that crop are selected and are added to the portfolio in the optimal amount at the optimal time.
The idea here is to approach the efficient frontier, which is a mathematical approach to maximizing total returns given different levels of risk. This calculus will constnatly be retooled as market conditions change, the portfolio’s value changes, and alternative assets that could be added to the portfolio also change in value.
Quickly, one can see how this attempt to create order out of a chaotic system with many variables suddenly becomes a mathematical behemoth.
The PM’s job is find better and better ways of accomplishing this take, and a good PM will do so in a way that noticeably improves performance on the whole. In reality, finding the efficient frontier often is about identifying and managing risk rather than boosting profits. But a good PM knows that both are opposite sides of the same coin.