A new paper published by global think-tank ‘Focusing capital on the long term’ (FCLT) has laid out clear criteria for funds looking to sack underlying asset managers – with short-term performance drift well down the list.
According to the just-published FCLT ‘Long term portfolio guide’ http://www.fclt.org/content/dam/fclt/en/ourthinking/FCLT_Long-Term%20Portfolio%20Guide.pdf , well-selected managers “should rarely be fired for short-term underperformance relative to quantitative measures”.
“However, dismissal may be justified if the manager deviates significantly from the investment mandate without adequate transparency and explanation,” the FCLT study says. “Dismissal may also be justified if the fund manager’s organization fails to communicate its actions and performance effectively or has lost necessary competencies.”
The report, based on input from over 20 global institutional investors including the New Zealand Superannuation Fund (NZS), says managers should be judged regularly on a range of qualitative factors such as:
- key personnel changes/corporate ownership;
- robustness of stated process, and adherence to beliefs and philosophy;
- evidence of effective risk management;
- ability to coherently express ideas and effectively implement them;
- transparency of decision-making and performance attribution; and,
- loyalty to research agenda.
But the paper also warns funds to carefully consider the benefits of dumping underlying managers.
“A study of pension-plan sponsors that fired their asset managers showed that if the asset owners had retained these managers, their excess returns over benchmarks would have been no worse on average and often better than those delivered by the managers they then hired,” the FCLT study says.
“In addition, the asset owners would have saved the substantial transaction costs of a manager transition, which often range from 1 to 2 percent of the assets involved.”
In all, the FCLT report details five “core action areas” to help institutional investors build better long-term approaches.
“We believe these five areas [investment beliefs, risk appetite statement, benchmarking process, evaluations and incentives, and investment mandates] collectively provide a framework for institutional investors to improve long-term outcomes for their portfolios, their investee companies, and ultimately for all stakeholders,” the report says.
The FCLT study concludes excessive short-term noise has skewed market prices away from long-term values and created greater volatility.
“This relentless focus on short-term results is self-defeating because it ‘undermines corporate investment, holds back economic growth, and lowers returns for savers’,” the report says.
However, institutional investors have a “fiduciary duty” to invest for the long term, the FCLT study claims.
“By investing counter-cyclically, long-term investors strengthen the market itself. Those who can invest long term should invest long term.
“Institutional investors should deliberately determine and allocate an organizationally meaningful proportion of their assets to long-term strategies, and reorient their portfolio structure and strategies to do so.”
FCLT formed in 2013 in a joint venture between the Canadian Pension Plan Investment Board and McKinsey & Co “to develop practical structures, metrics, and approaches for longer-term behaviours in the investment and business worlds”.
Adrian Orr, NZS chief, has also published an article highlighting the fund’s long-term ambitions.