Numerous studies have shown that actively managed investments
generally carry more risk and lower returns than globally
diversified, risk-calibrated index portfolios. Despite
this fact, governing boards of institutions frequently
fall prey to manager-picking consultants and the allure
of past winners, hiring the hottest new fund managers only
to fire them later because their past performance doesn’t
persist in the subsequent periods. A recent study conducted
by Amit Goyal of Emory University and Sunil Wahal of Arizona
State University found that manager hiring and firing decisions
made by consultants and board members was a complete waste
of money and the board members’ precious time. |
“The Selection and Termination of Investment Management
Firms by Plan Sponsors” reveals the negative impact of
manager chasing. The results, as set forth in the figure
below, demonstrate that during the ten-year period from
1994 through 2003, consultants and boards which based their
fund manager hiring decisions on consistent above benchmark
past performance were largely disappointed with subsequent
index-like results. They often then fired their managers
in favor of another recent top performer, repeating the
cycle again. This cyclical motion undermines their investment
policy statements and the opportunity of achieving optimal
returns, the kind of returns that are available by simply
buying, holding and rebalancing a passively managed portfolio
of index funds that keeps costs low and controls risk. |