Institutional investors do not act on their own expectations when choosing fund managers, rather their reliance on consultants, and past performance, exacerbates the agency problem in the institutional investment supply chain a new study from Oxford University shows.
Using survey data for 1999-2011 the academics analyse the views of plan sponsors on their asset managers, it covers investors with assets of about $7.6 trillion.
Using survey data institutional investors’ expectations about the future performance of fund managers and the impact of those expectations on asset allocation decisions is analysed.
“We find that institutional investors allocate funds mainly on the basis of fund managers’ past performance and of investment consultants’ recommendations, but not because they extrapolate their expectations from these. This suggests that institutional investors base their investment decisions on the most defensible variables at their disposal, and supports the existence of agency considerations in their decision making,” the study says.
The analysis looks at future manager performance as a function of three sets of possible determinants: first, the past performance of the asset managers; second, various non-performance attributes which plan sponsors identify in those asset managers; and third, the recommendations of asset managers by investment consultants.
The study then sets the plan sponsors’ expectations, and the possible drivers of these expectations, against the actual future performance of the asset managers. And the compares the plan sponsors’ expectations of asset manager performance, as well as past performance, consultants’ recommendations, and other factors, with the fund flows in and out of asset managers.
“This analysis allows us to test whether the well documented correlation between fund flows and past performance results from investors extrapolating future performance from past performance, or from agency problems, or both. If the correlation between fund flows and past performance results from plan sponsors extrapolating future performance from past performance then any influence of past performance on flows should be channeled through its effect on the expectation of future performance and, to the extent that these measures disagree, only expected future performance should matter. Money should not flow to funds with good past performance unless investors expect these funds also to do well in the future, and as a result only expected future performance, not past performance should be significant in a multivariate regression,” the study says.
The study finds that fund flows are driven by consultant recommendations and past performance of the fund managers.
“The fact plan sponsors do not act on their own expectations, or do so only marginally, when making investment decisions is consistent with agency rather than behavioral effects on the part of plan sponsors. A behavioral explanation for this would require us to believe
that plan sponsors take the trouble to form expectations about the future but then, unwittingly, fail to act on those expectations. It seems more likely that their actions are at variance with their own expectations because they feel that past performance and consultants’ recommendations are a more defensible explanation for their decisions.”
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