Investor behaviour erodes performance

Performance is eroded by institutional investors’ decisions around hiring and firing managers according to the preliminary results of a behavioural study by Boston University that links qualitative factors such as committee characteristics with earlier empirical research on performance.

In research published in the Financial Analysts Journal in 2009, Absence of Value: An analysis of investment allocation decisions by institutional plan sponsors, by Boston University business Professor Scott Stewart, and others, concluded that institutional investors eroded value from changing manager allocations.

Now, that research has been expanded, by combining the results of a 2004 research study that interviewed more than 100 plan sponsors, with the asset allocation and performance results of those funds five years before and after the survey.

According to Stewart, speaking at a CFA Institute webinar in December, the purpose of the study is to try and understand how the characteristics of a committee structure, the decision making, areas of expertise and training can influence decisions, and get a better understanding of what is happening with manager selection.

The preliminary results from the survey and other analysis, indicate that the prior results – that managers receiving flows underperform those with outflows – have been confirmed.

The 2009 research looked at investment management data from the Effron database from 1985-2006, measuring the performance of the managers that received contributions, and those that experienced withdrawals.

By looking at the percentage difference in performance of those managers with the highest flows, and those with the lowest flows (by quintile), it concluded managers receiving contributions underperform those which experience withdrawals.

Further, this underperformance persists over one, three and five years, and can be up to 300 basis points.

“Collectively plan sponsors are losing billions of dollars a year through their manager allocation decisions,” Stewart.

The study went on to expand the analysis beyond just quintile assessment, looking at the percentage difference between flow-weighted and account-weighted portfolios.

It found that the impact of one-year decision making on the next five years of dollar performance results in a $170 billion loss.

“This figure is larger than the number being spent on investment management fees and doesn’t include any transaction costs,” Stewart said.

The research also looked at the source of lost value, and through Brinson analysis attributed the vast majority (up to 75 per cent) to manager selection, rather than asset allocation or style selection.

Stewart advised plan sponsors to evaluate their hire and fire decisions, and track the performance of the managers they have terminated, and those on their short list, as well as those they have retained.

In addition he warned investment managers: “Your clients may select you simply because you have a good track record, which means they may give up on you when your short-term performance is poor.”