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The Selection and Termination of Investment Managers 投资管理人选择

Investment Manager Selection & Due Diligence

Investors demand actively managed investment strategies so they pay extra to hire investment consultants; consultants perform manager due diligence, and advice investors in the asset allocation and portfolio optimization phases. After manager selection, the portfolio construction process will be about optimizing around talents by integrating active where you find skills with passive where you don’t, constantly monitoring, assessing positions, and periodically re-balancing.

When comparing individual manager performance relative to the universe (peer groups), please note that inappropriate style classification, benchmark selection, and survivor biases may negatively impact our judgement. With that said, more and more U.S. institutional investors are using customized benchmarks.

Since performance results are backward-looking, hiring an investment manager is not just performance; instead, it’s more about investing in people. In adding a new manager, the process starts by studying the appropriate universe of candidates: on the qualitative side, we consider factors such as firm background, investment professionals’ skills and team stability, strategy capacity, reputation in the industry, investment philosophy and approach, business operations, compliance, external auditors, etc.; on the quantitative side, we look to screening process, historical performance (not only examining the individual strategy composite performance, but also simulating the potential interaction effect with the rest of investments in the portfolio), buy/sell disciplines, financial strength, etc. The due diligence process also covers RFPs and on-site visits. It is critical to have a well-defined process and stick to it.

In addition to the performance- and quality-based assessment, we should also make sure that each strategy has an opportunity set, which means that before making an allocation to a strategy, consider what might cause its ability to generate alpha to be short-lived.

Termination of Investment Managers

Investment consultants may consider terminating the relationship with an investment management firm or downgrading specific products if issues such as the following occur:

  1. Underperformance is probably the leading cause of manager firings; however, sometimes the underperformance may be simply a reflection of a broader market decline, or the investment style of the new portfolio manager, so we should assess that whether or not the results are consistent with the manager’s stated investment philosophy and objective
  2. Key employee turnover, as we often view the superior performance of investment portfolio as being directly attributable to a particular individual
  3. Regulatory issues, e.g. in the U.S., the SEC violation
  4. Changes in the shareholder stability or ownership structure, such as mergers between investment firms, which implicitly increase operational risk; furthermore, we assess the composition of boards, specifically, the true independence of the independent directors
  5. If the investment manager decides to switch asset classes or style focus
  6. If the manager increases management fees or operating expense ratios without reasonable reasons
  7. High portfolio turnover – an inverse relationship exists between a fund’s portfolio turnover and its returns
  8. “Shelf space.” When funds pay for “shelf space” to build distribution, fund advertising finds a baneful counterpart – spending shareholders’ money to gain even more assets.
  9. If the manager aggressively shifts total portfolio risk around in a manner, or the manager “window-dresses” the portfolio at period ends
  10. If the manager does not focus on investment fundamentals
  11. If the manager does not assume the rights and responsibilities of corporate governance
  12. If the manager does not take on an activist role in assuring that the companies whose shares our institutional manager hold and control are run in the interest of the investors whom we are bound to serve as fiduciary agents
  13. Beware of growth in assets under management (AUM). Strategies that work in small volumes may not be as successful on a larger scale, but a big change in AUM might also suggest the manager is disproportionately focused on asset gathering instead of investing. In addition, beware of big sideline interests that might compete for the manager’s focus

Amit Goyaland & Sunil Wahal (2008) study over 1,000 funds and find that institutional investors hired managers who had much stronger performance than the ones they had fired but that the newly hired managers underperformed the fired managers, on average (sounds like buying high and selling low). Hiring and firing decisions can be justified ex ante. Ex post, there are opportunity losses; unfortunately, it is difficult to estimate losses such as opportunity costs and frictional costs in moving portfolios. Practitioners in the public press suggest that “the average transition costs range between 2% and 5% of the portfolio, with a standard deviation of 1%”.

In addition, the sensitivity to headline risk could also influence hiring decisions: 1) it could be that increased public scrutiny improves incentives and so as the results in higher post-hiring performance; 2) thinking about it in an opposite way, headline risk sensitivity could be a response to the lack of incentives to generate superior performance. Generally speaking, the performance of headline-risk-sensitive products is negative.

A Comparison of Institutional Investment to the Retail Investment:

The research in retail investment (mutual funds) involves: 1) performance review and the persistence of the results; 2) studying the relationship between fund flows and returns; 3) analyzing investment choices made by individual investors. In this space, Goyaland and Wahal find that:

  1. The level of excess performance and the degree of persistence is weak
  2. The relationship between fund flows and returns is convex
  3. Retail investors make investment choices that can be construed as suboptimal

By contrast, in examining the institutional universe, Lakonishok, Shleifer, and Vishny (1992) persuasively argue that there are significant conflicts of interest in the industry. Organizational structure and incentives can generate tremendous variation in behaviors. Beyond that, size also generates variation in the process. A simple way to think about this is the presence of scale dis-economies, since future returns could deteriorate at higher trading costs. Finally, the interaction effect between mandate and investment consultants use is negative; investment consultants work under restrictions imposed by institutional clients, but such imposition of restrictions is detrimental to portfolio performance.

Reference:

The Selection and Termination of Investment Management Firms by Plan Sponsors – Amit Goyaland & Sunil Wahal

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