INSIGHTS

On July 18, 2012

WARNING: Poor Performance! When to Hire or Fire a Manager

If you or your clients invest in third party managers, you will undoubtedly have faced this question at some point in time: “My manager is under performing, should we fire them?” On the flip side you also probably faced the question: “This manager is performing very well, should I hire them?”

The unfortunate reality is that many investors and advisors might make decisions solely based upon short-term performance. Tower Watson, a global consulting firm, recently conducted a study on investors who stick with managers who are under performing and those who are “trigger happy.” What might surprise you is that, according to their research, those investors who stick with their managers throughout periods of underperformance significantly outperform those who actively fire managers trailing their benchmarks. Even worse, their study shows that those investors who actively hire and fire managers underperform even index funds.

According to Tower Watson, there are three main factors affecting the performance of those “trigger happy” investors. First, is the transaction costs incurred by selling out of one strategy and buying into the next. Second, most managers have cyclical performance patterns which means the investor could be missing out on what could be outperformance in the coming years. The third reason is similar to the second; if the investor sells out of one strategy for another, they are likely buying into a strategy at the top of its cyclical performance cycle.

So, if hiring and firing managers based upon their performance doesn’t work, how do successful investors select managers? It’s important to focus more on the process the manager is using for their strategy rather than just on performance. Positive performance actually becomes a byproduct of a quality manager and process.

Advisors and investors evaluating a manager should consider:

• Manager’s ability to achieve objectives.
  
  • Are you looking for income?
  • Are you looking for growth?
  • Are you looking for stability?

• Was performance expected?
  
  • Did you expect this performance if certain events happened? For example, is this a strategy that focuses on a specific asset class or excludes a specific asset class?

• Have there been significant changes to the management style?
  
  • Have there been excessive personnel changes?
  • Has the management team altered their investment style?
  • Even with lagging performance, is your account achieving its objective? For example, a fixed income account might show lagging performance based on statement values, yet still provide high income to the investor.

Before making a decision on the manager, be sure to answer these questions and be comfortable with their investment style. Remember, although performance is important it will always represent a past figure. It’s important to focus on what the manager will do for your account in the future.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com/blog.