Contrary to what many in the industry believe, allocators aren’t quick to to fire investment managers. But when they do terminate firms, it’s because of underperformance.
According to new research based on asset owner data collected by Institutional Investor, 66 percent of allocators are willing to hold underperforming public equity managers for at least three years, if not longer.
Researchers from Michael Mauboussin to Commonfund’s Mark Anson have long chronicled the pitfalls of terminating managers too early. This has led some managers and consultants to come to the conclusion that asset owners are too quick to drop managers, and that they’re losing out on potential returns because of it.
“There is this belief out there that institutions are very quick [on] the trigger,” Arizona State University researcher Sunil Wahal said. “They’re willing to hire and fire investment managers for whatever reason, [and they’re only] willing to tolerate them for short periods of time. They’re a bit like an impatient parent.”
But according to new research, this isn’t actually the case.
Institutional Investor collected data from 218 organizations in 22 countries representing $4.1 trillion in assets under management, surveying those asset owners to find out why they terminate their managers. The makeup of these allocators included public and private pension plans, endowments, foundations, insurers, financial institutions, hospital systems, family offices, sovereign wealth funds, and central bank reserve funds.
Wahal, along with researchers Amit Goyal from the University of Lausanne and the Swiss Finance Institute, and Ramon Tol from the Blue Sky Group, interpreted that data and published a paper. They found that for equity and fixed-income managers, holding periods are relatively long — 68 percent of respondents said that on average, they hold their equity managers for more than five years, while 65 percent said the same for fixed-income managers.
“One of the things that strikes me [in] this survey is that they’re a lot more patient than we expected them to be,” Wahal said.
They’re also tolerant of underperformance. Sixty-six percent said that they would be willing to deal with poor performance in public equity for three years or longer. Fifty-six percent said the same for fixed income.
North American asset owners are the most patient, according to the research. They are the most likely to hold onto equity and fixed-income managers for more than five years, as compared to their global peers.
“Americans are generally viewed as extraordinarily impatient,” Wahal said. “That doesn’t appear to be the case at all.”
But when they finally fired managers, it was more often over performance issues, as opposed to risk or organizational concerns.
For hedge funds, though, that may well be true. Investors surveyed appear to be less lenient toward hedge funds, with 42 percent reporting an average holding period of more than five years for these managers. Just half said that they’d be willing to tolerate poor hedge fund performance for three years.
The survey was completed in 2021, however, and with recent market performance benefiting many hedge fund managers (and causing losses for equity and fixed-income managers), that could change. “The asset allocator has to be very careful, as scientific as possible,” Wahal said, referring to allocators’ concerns that they are always making a mistake by firing managers too early. “They have to recognize that overcompensating is potentially a problem, especially because the asset manager is going to give them signals that they’ll overcompensate.”