We are constantly singing the praises of examining fundamentals when choosing stocks, but a similar process applies when evaluating the performance of portfolio managers,  says Jacques Lussier, CFA and CEO of Ipsol Capital. In a recent Take 15 interview for Enterprising Investor, Lussier shares his insights about the value of “factor-based benchmarks” when distinguishing effective managers from lucky ones.

“Some managers,” says Lussier, “have good performance because they have good process” but some show well “because of a single glimpse of genius never to be repeated again.” He looks for three qualities when determining whether a manager can generate alpha:

• Intellectual curiosity: Few managers, Lussier contends, “stay abreast of current literature.”
• Ability to distinguish “the signal from the noise.”: He explains that usually “no more than 10 factors account for 90% of the variance a manager can explain.”
• Being intuitive to investors: Managers that embrace the same investment philosophies and levels of risk can build “widely divergent” portfolios. Those with the least complex portfolios, Lussier argues, tend to have a better understanding of the issues.

Factor-model-based benchmarks, which relate systematic sources of returns to the performance of the benchmark, have “the most potential to isolate statistically reliable alpha.” But Lussier asserts that there is a resistance to this. “A lot of managers,” he says, “would not like their investors to know what their sources of alpha are, because they might find out they’re not exactly alpha.”