Manager Selection
January, 2018
Scott Stewart, CFA
Cornell University
Show of Hands
Do you think that
institutional investors
add value from their
manager selection
decisions?
Yes, No or I Don’t Know
2
Today’s Discussion
3
The Investment Business
1. Business people rewarded
once assets arrive, and
stick
2. Portfolio managers
rewarded once they
outperform their
benchmarks
4
What is Reward for Clients?
Wouldn’t it be interesting…
to collect all the hirings and firings of
investment managers,
determine why these decisions were made,
and whether or not they added value?
And use the results to improve the industry…
5
Today’s Topics for Discussion
1. Scott’s research (2007 on)
2. Key book observations (2013/14)
3. Key takeaways
6
Scott’s Three Research Studies
1. Institutional manager selection process
(1985-2000)
2. Performance of hiring/firing decisions
(1985-2006)
3. Survey of institutional investor decision
process (2004…)
7
First Two Studies—Research Design
Empirical Study—Research Design
Examine flows
between managers
1. Explain flow activity
2. Test subsequent performance
Informa database:
Returns & Characteristics
on over 7000 Inst’l Products
8
Informa Database—Asset Levels
5,000
Balanced
Equity
Fixed
Assets in Billions
Total grew to exceed
$10 trillion by 2007
4,433.9
4,500
4,000
3,500
3,000
2,445.7
2,500
1,857.6
2,000
1,488.6
1,500
1,000
570.2 472.5
500
78.6
202.4 104.6
420.7
354.6
211.9
0
1985
1990
1995
2000
FYI: Asset Flows represent 10% per year on average
9
Results of First Study: Drivers of flows
Asset and Account Flows:
“Why do… Hire and Fire…”, JBES (2007)
Institutional investors
1. rely on benchmark-relative performance, not simply
total return
2. are not overly focused on short term results
3. pay attention to style, but do not necessarily adjust for
style extremeness
4. rely on return pattern more than simply cumulative
returns
5. require more evidence before terminating an account
10
Part One of Second Study: Subsequent Performance
Financial Analysts Journal, 2009
Basic Question: Do institutional
investors add value from changing
manager allocations?
Statistical results suggest…
Managers who receive contributions tend to underperform managers who experience withdrawals
Based on over 80,000 annual
observations between 1985-2006
11
Subsequent Performance—WEIGHTED Results
% Difference in Performance:
FLOW Weighted and ACCOUNT Weighted Portfolios of Managers
(1985-2006)
FLOW-WEIGHTED
1-year
Difference in
Annualized Returns
0
-1
-2
-3
-4
-5
-6
-7
-8
-9
1-Year
5-Year
5-years
ACCOUNT-WEIGHTED
1-year
5-years
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
-2.0%
-3.0%
-4.0%
Pre-Flow
Post Flow
NOTE: Collectively, plan sponsors are losing
billions of dollars a year through their manager
allocation decisions!
12
Part Two of Second Study: Sources
Key Question: Which decisions lose value?
•
Are they good at setting asset allocation but not at manager
selection?
•
Do they add value at the category or style level but destroy
value once it is implemented?
Statistical results suggest…
Investors lose value at the style and mostly
manager selection decision levels, and a little in the
short term from asset allocation decisions
13
Sources of Loss of Value—One-Year Periods, 1986-2006
Brinson Analysis: Category versus
Product Selection
Category
Product
Interaction
0
-0.1
-0.2
-0.3
-0.4
-0.5
-0.6
-0.7
-0.8
14
Current Study: Survey of Plan Sponsors
2004 Survey Study
1. Confirms many research results
2. Identifies non-performance criteria
– Communication skills
– Reputation
– Consultant input
3. Mixed perceptions of investment performance
15
Summary of Other Survey Results
• Plans with consultants and higher education
levels turn plans over to a greater extent
• More “functional” plans evaluate decisions to
a greater extent, have fewer asset classes
and higher turnover
• Tainted managers are terminated to a greater
extent by public plans, yet only if
performance is poor
16
Book’s Key Observations
17
Other Research Studies’ Results
1. Using institutional data
–
Confirm Scott’s results
–
Identify evidence of statistically significant
manager skill and persistence in consistency

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
R


R

R

ep
.
p
f
p
M
f
2. Using mutual fund data
–
Limited evidence of statistically significant manager
skill (table 2.7)
–
Limited evidence of persistence (table 2.9)
–
Some evidence of short-term manager
selection skill
18
What did Scott learn from Manager Selection?
1. Active manager skill does exist
2. It is very difficult to identify skillful managers
(after fees) in advance, especially in public
markets
3. In some markets it may be worth the effort
4. There are things we can do to improve
results
19
Cool Stuff in CFA Book
In addition to information on the record of active
management and manager selection…
• The arithmetic of active management
• Index fund selection
• Mixing fund managers
• Lists of guidelines and key
recommendations
• Excel tools
• Bibliography
20
Cool Summary of Research on Qualitative Factors
21
Cool Summary of Research on Manager Success
22
Book’s Key Recommendations
23
Recommendations for Plan Sponsors
1. Don’t follow fashion…seek valuation
2. Know difference between deep value and
relative value
3. If everyone wants you to fire manager, ask
yourself if you’re selling at the bottom
4. Evaluate your process, not just your current
managers
5. Look at managers’ portfolio construction
24
Observations for Managers
• Your clients may select you simply because your
track record (style may not be adjusted for fully)
looks good
• They may give up on you when short term
performance is poor
• There’s a good chance this decision is a mistake
• Keys: know your client and develop good
communication
25
Recommendations Regarding Communication
• Communicate frequently, begin by managing
expectations
• Communicate more if performance weakens
• Demonstrate, and then explain
– Why performance weak
– Portfolio characteristics & performance consistent
with process
– Performance tends to reverse
• Good followed by weak
• Really good followed by weaker
26
Business Recommendations
Pick an attractive asset class
Hire skillful managers
– Bright & knowledgeable
– Focused
Structure appropriate incentives
– Long term view
– Independent decision making
– Alignment of interests
Understand portfolio construction
27
Final Recommendation
NEW RESEARCH RESULTS:
– Survey of Plan Sponsors
– Perceptions on confidence, importance to study
process performance and control variables
– t-stat on “importance to study process performance”
= 0.089
KEY RECOMMENDATION: Evaluate your process,
not just your current managers
28
Manager Selection
Thank you
29
Scott’s Contact Information
EMAIL: sds58@cornell.edu
30
Appendix
31
More on Drivers of flows
1. Most assets flow to managers
with good one, three and fiveyear numbers
2. Poor one-year number not a
big problem
3. A really bad one-year number
is
4. A poor 5-year number not a big
problem if one and three-year
numbers good
32
FAJ Study: DATA
• 1985-2006, over 80,000 annual
observations
• Equity, fixed, international & global
• Industry assets grew from $320 B to $13.5 T
• Includes mutual fund data in later years
• Tested for survivorship bias
33
Initial Analysis: Subsequent Performance—
QUINTILE Results
% Difference in Performance:
Highest Flow Quintile Managers minus Lowest Flow Quintile Managers
(1985-2006)
1-Year
5-Year
1-year
0
3-years
5-years
5.0%
4.0%
Difference in
Annualized Returns
-0.5
3.0%
-1
2.0%
-1.5
1.0%
-2
0.0%
-1.0%
-2.5
-2.0%
-3
-3.0%
-3.5
-4.0%
Pre-Flow
Post Flow
These results are statistically significant.
34
Subsequent Performance—DOLLARS
Flows (100’s of Billions) and Value Lost (Billions)
(1985--2006)
Inflows (100's of
Billions)
$Billion Impact
from 1-year
Active Flows
$Billion Impact
from 5-year
Active Flows
180
160
140
120
100
80
60
40
20
0
Collectively, plan sponsors are losing billions of dollars a year
through their manager allocation decisions!
35
Third, Survey Study
test for perception on investment performance
Results suggest apparent inconsistency
between perception and reality.
Topic
Disagree Performance Deteriorates
Believe Manager Performance Good
Disagree Performance Improves
t-stat
4
10
4
36
So…What’s Going On?
• Respondents agree they evaluate subsequent
performance of decisions and believe their
decisions are appropriate and effective
• Yet the More Experienced See It
Some respondents seem to appreciate
performance reversals to a greater extent
37
Performance Chasing May be a Problem
1. 98% believe returns are important
2. 85% require minimum of 3-yr record
3. Anticipated changes in asset class
allocations correlated with trailing returns
Increase/
(Increase+Decrease)
1.2
1.0
0.8
Regression Line
0.6
0.4
0.2
0.0
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
20.0%
3-Year Trailing Return
38
Influence of Performance Chasing on Turnover and Performance
Percentage Disappointed with
Supplier Performance
Average Manager Turnover
7.0%
6.4%
13.0%
6.0%
4.8%
5.0%
12.0%
12.0%
4.0%
11.0%
3.0%
10.0%
2.0%
10.0%
1.0%
0.0%
1
2
High Level of
Performance Chasing
Low Level of
Performance Chasing
t = 2.4
9.0%
1
2
High Level of
Performance Chasing
Low Level of
Performance Chasing
Not statistically significant
1.
39
Sample References
Presentation based upon:
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Investment Allocation Decisions by Institutional Plan Sponsors.” Financial Analysts Journal, 65(6),
34-51, Nov/Dec.
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Institutional Plan Sponsors Hire and Fire Their Investment Managers?” Journal of Business and
Economic Studies, vol. 13, no. 13 (Spring):88–115.
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