manager selection: evidence, methods for …mmd.cfainstitute.org/pdf/2014/10530_stewart.pdf1 a cfa...

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A CFA Institute Productionwww.cfainstitute.orgSlides provided by speaker

Manager Selection: Evidence, Methods for Selection, and Techniques for Managing

Scott D. Stewart, CFA Member of the Board of DirectorsBoston Security Analysts Society

4 May 2014

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The Investment Business

1. Investors seek to hire the managers who will deliver

2. Portfolio managers rewarded if they deliver strong results

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Does the Business Work?

Wouldn’t it be interesting to collect all the hirings and firings of investment managers, determine how that worked out, and use the results to improve the profession?

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Pre-Conference Survey

“Do you think that institutional investors add value from their manager selection decisions?”

63% say yes11% say no26% are not sure

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Today’s Topics for Discussion

1. Scott’s research2. Others’ research3. Key book observations4. Excel workshop5. Key take-aways

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Research Results

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Scott’s Three Research Studies

1. Institutional manager selection process (1985–2000)2. Performance of hiring/firing decisions (1985–2006)3. Survey of institutional investor decision process (2004…)

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Examine flows between managers

1. Explain flow activity2. Test subsequent performance

Effron database:Returns & Characteristics

on over 7000 Inst’l Products

First Two Studies’ Designs

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Effron Database — Asset Levels

78.6211.9

420.7 354.6570.2

2,445.7

4,433.9

104.6202.4

1,488.6

1,857.6

472.5

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

1985 1990 1995 2000

BalancedEquityFixed

Assets in Billions

FYI: Asset Flows represent 10% per year on average

Total grew to exceed $10 trillion by 2007

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Results of First Study: Drivers of Flows

Asset and Account Flows: “Why do… Hire and Fire…”, JBES (2007)

Institutional investors

1. rely on benchmark-relative performance

2. are not overly focused on short term results

3. pay attention to style, but do not necessarily adjust for style extremeness

4. require more evidence before terminating

5. rely on return patterns

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Subsequent PerformanceFinancial Analysts Journal, 2009

Basic Question: Do institutional investors add value from changing manager allocations?

Statistical results suggest:

Managers who receive contributions tend to under-perform managers who experience withdrawals

Based on over 80,000 annual observations between 1985–2006

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Weighted Results% Difference in Performance:

FLOW Weighted and ACCOUNT Weighted Portfolios of Managers(1985–2006)

FLOW-WEIGHTED ACCOUNT-WEIGHTED

NOTE: Collectively, plan sponsors are losing billions of dollars a year through their manager allocation decisions!

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

Pre-Flow Post Flow

Diff

eren

ce i

n An

nual

ized

Ret

urns

1-Year5-Year

-9-8-7-6-5-4-3-2-10

1-year 5-years 1-year 5-years

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Part Two of Second Study: Sources

Key Question: Which decisions lose value?

• Are they good at setting asset allocation but not at manager selection?

• Do they add value at the category or style level but destroy value once it is implemented?

Statistical results suggest:

Investors lose value at the style and mostly manager selection decision levels, and a little in the short term from asset allocation decisions

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Sources of Loss of Value, 1986–2006

Brinson Analysis: Category versus Product Selection

-0.8-0.7-0.6-0.5-0.4-0.3-0.2-0.1

0Category Product Interaction

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1. Confirms many research results2. Identifies non-performance criteria

• Communication skills• Reputation• Consultant input

3. Mixed perceptions of investment performance

Current Study: Survey of Plan Sponsors

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1. Using institutional data• Confirm Scott’s results• Identify evidence of statistically significant manager skill, and persistence in

consistency

2. Using mutual fund data• Limited evidence of statistically significant manager skill (table 2.7)• Limited evidence of persistence (table 2.9)• Some evidence of short-term manager selection skill

Other Studies’ Results in Manager Selection

.p f p M frp R R R ep

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Research Results on Qualitative Factors

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Useful Things in the Book on Manager Selection

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1. Active manager skill does exist2. After fees, it is very difficult to identify skillful managers in

advance, especially in public markets3. In some markets it may be worth the effort4. There are things we can do to improve results

What Did Scott Learn from Manager Selection?

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1. Don’t follow fashion…seek valuation2. Know difference between deep value and relative value3. If everyone wants you to fire manager, ask yourself if you’re

selling at the bottom4. Evaluate your process, not just your current managers

Key Recommendations for Plan Sponsors

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Key Observations for Managers

• Your clients may select you simply because your track record (style may not be adjusted for fully) looks good

• They may give up on you when short term performance is poor• There’s a good chance this decision is a mistake• Keys: know your client and develop good communication

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Other Cool Stuff in CFA® Book

In addition to information on the record of active management and manager selection…

• The arithmetic of active management• Index fund selection• Mixing fund managers• Lists of guidelines and key recommendations• Excel tools• Bibliography

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Summary Recommendations for Manager Selection (p 107–110)

1. Part-time investors should avoid reacting to performance2. Investors should be disciplined3. Formulate selection process in IPS4. Evaluate process5. Constantly improve skill set6. Consider 100% in cash

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Features of an Attractive Search

1. Define goals2. Determine selection skills3. Document costs4. Prepare questions5. Document manager process6. Explore fees7. Define measures of success

Don’t wait for poor performance to review manager

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Excel Workshop

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Optimal Mixing of Managers

Case: Set weights of four small-cap US equity managers• Core Active, Value, Growth, and Indexed

Objectives: Four alternative mixes1. Equal Weight2. Minimum active risk3. Maximum tradeoff between risk and return4. Beta-constrained

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A Few Definitions

Active Return: rs – rb

Active Risk: σ (rs–rb)

Utility: E(rs–rb) – λ σ (rs–rb)

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Excel StepsIn-sample exercise:Need columns of returns, calculations of active returns, risk and utility, weights, and Solver

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Excel Worksheet

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Excel Worksheet (2)

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Excel Worksheet (3)

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Excel Worksheet (4)

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Fund Characteristics

Index Value Growth Core

Beta 0.99 0.84 1.04 0.91Act. Ret. ‐0.3% 1.0% ‐0.2% 1.1%S.D. 1.7% 7.0% 7.8% 6.1%

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Results

Largest Weight: Indexed Core Indexed

Equal Wtd Min Risk Max U

Max U, Beta = 1

Beta 0.9 1.0 0.9 1.0Act. Ret. 0.5% ‐0.3% 1.2% 0.0%S.D. 3.7% 1.6% 5.1% 3.4%

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