Report: Firing Underperforming Managers Is Counterproductive

(June 18, 2012) — Attempting to dissuade investors from becoming too “trigger happy,” a report from consultancy Towers Watson suggests that asset owners who are quick to fire underperforming managers may be limiting their possible returns.

The report looks at two hypothetical investors—“disciplined Dan,” who resists the urge to be “trigger happy,” and “trigger-happy Tom,” who, as his name suggests, does not—who hire the same active manager. Factoring in transition costs and the cyclical nature of excess returns, the report concludes that Tom’s portfolio would significantly underperform Dan’s.

“We find that a disciplined investor profits from using the active manager, whilst a trigger-happy investor would fare better with an index fund,” the report concludes.

Decisions to sack underperforming managers are further exacerbated by the reality that asset owners often have difficulty accurately gauging their true value. A Towers Watson paper released in April tackled this problem, and recommended a Bayesian statistical approach as the best way to make such evaluations.

In May, aiCIO interviewed Segal Rogerscasey’s Jason Bailin, who spoke at length on the issue of terminating money managers. He advised that decisions to do so need to be as emotionless as possible.