(October 1,
2013) – We know we shouldn’t, but it seems we still do: Aon Hewitt EnnisKnupp has
reminded investors about the dangers of only looking at recent performance when
selecting a fund manager.
Analysis
carried out by the consultancy of outperforming and underperforming fund
managers across the world showed the idea of mean reversion to be factually
correct, meaning what performs well today won’t necessarily perform well
tomorrow.
Mean
reversion theory suggests that strong periods of outperformance can be followed
by less attractive results, and that frequently strong periods of
underperformance can be followed by improved returns.
The study
looked at two distinct groups – equity managers which were below benchmark
performance after looking at five years’ worth of returns up until 30 June,
2008, and those equity managers who outperformed over the same period.
EnnisKnupp
then tracked the performance of both groups, relative to benchmark, in the
subsequent five years to June 30, 2013.
The data,
provided by eVestment Alliance, showed that those underperforming managers saw
their returns improve, while the high flyers saw their returns fall.
“These
trends can directly impact client portfolios when making decisions about hiring
and firing managers. Typically clients terminate managers after periods of
underperformance. Our analysis shows that investors can be better off by being
patient with underperforming managers, especially those that have not
experienced material changes in staff or process,” wrote Chris Riley, associate
partner at EnnisKnupp.
“Investors
are also better off selecting managers based on criteria other than just
chasing past returns; managers that are hired after a strong run of
outperformance often have difficulty sustaining significant levels of
outperformance.”
The full
report can be found here.
It’s not
just investors who are accused of getting the hiring and firing decisions wrong
though: on an equal-weighted basis, US equity
funds recommended by consultants underperformed other funds by 1.1 % a year
between 1999 and 2011, according to analysis by Oxford University’s Said
Business School.
Mitesh
Sheth, consultant at Redington, accepted that some consultants were guilty of
box-ticking when it came to manager research, but stressed there were ways of “getting
under the bonnet” and choosing the right fund manager.
Sheth said: “Fund
managers are hugely incentivised to say the right thing and to avoid saying
anything that might cause concern. The rewards for getting it right are massive
and the cost of getting it wrong is bigger.
“Fund
managers get coached, briefed and trained ahead of due diligence research
visits. Only the best communicators are usually presented to researchers. This
understanding is so ingrained that roles and promotions often depend critically
on communication skills in consultant and client meetings. These many layers of
polish take some getting through.”
To cut
through the polish, Sheth recommends doing the following:
1)
Compare stories for accuracy across different individuals in a team or have
face-to-face meetings with all the managers of a particular strategy/sector in
a short period of time;
2) Interview people at all levels of a company from CEOs, to
fund managers and analysts, to risk managers, operations, and support;
3)
Retain an element of surprise and visit managers at short notice; and
4)
Appeal to the “better angels” of fund managers’ nature, and share your own
research, on the chance that it moves the discussion towards an honest basis of
engagement.
You
can read more of Sheth’s tips here.
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