Vanguard recently surveyed institutional investors about the decision process behind fund manager changes. Catherine Gordon, Head of Institutional Advisory Services at Vanguard, discusses the findings with Morningstar Director of Personal Finance Christine Benz, and explains what factors individual investors should take into account when deciding whether to buy into or sell a fund.
Christine Benz: Hi, I'm Christine Benz for Morningstar.com. What factors should you take into account when deciding whether to hire or fire a fund manager? Here to discuss that question is Catherine Gordon. She is Head of Institutional Advisory Services for Vanguard. Catharine, thanks for joining me here today.
Catherine Gordon: Glad to be here, Christine.
Benz: So you recently conducted some fascinating research into this question of how investment committees decide whether to hire a fund manager or give him or her the heave-ho. And I wanted to talk about first what you found and also then talk about what the implications might be for individual investors from that research. So, first, let’s talk about the thought process that you see investment committees engaging in when deciding whether to hire or fire?
Gordon: Sure. We were very interested in that whole process, obviously as an investment management firm, how committees go about doing that and so we surveyed a number of committee members, got over 100 responses and some of which corroborated what we thought would be the answers and got a few surprising answers.
I think some of the things that we found in the research is performance plays a large role in whether or not to hire or fire an investment manager. But committees also looked at a number of other factors in that decision, placed heavy emphasis on style, consistency, fees played a large role.
On average the committees changed generally one manager a year and the one thing that kind of surprised us was that they found that it was harder to hire a manager than it was to fire a manager and we would have thought it would have been harder, given relationships, it would have been harder to fire a manager with whom they have had a relationship over a number of years, but it was actually quite the opposite. We also found that committees have a high degree – we felt they had a high degree of investment knowledge, so over 90% indicated that their investment knowledge was above average.
Benz: So I want to drill into a couple of these points. So, first of all, these are committees who are making decisions on behalf of foundations or institutions or some other entity. So in terms of this, easier to fire than hire, you are right, to me that seems really counterintuitive. What do you think is driving that tendency?
Gordon: I think it’s partially because it takes a lot of work upfront. Typically these committees are evaluating a number of potential managers, it takes time. So I think probably time – the fact that it’s harder is probably it takes more time on their part to evaluate the prospective manger. But as I said, that was one of the aspects of the survey that did surprise us.
Benz: And the overconfidence that’s something that has come up in the academic literature about investor behavior and general human behavior that we see people tend to overestimate their own ability. Is that something you found here with these committees as well?
Gordon: Actually in another dimension of the survey 63% of the responses indicated that they seldom made mistakes.
Benz: It’s like the people who are – the 90% of people who are above average drivers?
Gordon: …who are above the average drivers for it.
Benz: So let’s talk about performance. So you say that it’s a key decision-making factor. My question to you is, should it be, because certainly in all the data that we look at here at Morningstar we find that performance isn’t a particularly predictive data point?
Gordon: We would absolutely agree. I mean, certainly the research you have done, that we have done. When we look to hire managers to manage our funds, it’s one of the last things we look at. We are much more interested in the manager as a team or the investment process, their style, how solid is the firm itself as a business and usually performance is the outcome of all of that.
So it’s really a multi-dimensional valuation process and performance is one of the, as I said, it’s kind of one of the last things we look at should confirm that, okay, this manager's style has been in favor, they have a solid investment process, they are very consistent, it shouldn’t surprise us his performance is good and their style has been in favor.
Benz: Right. So, I guess the problem for individual investors certainly attempting to make these decisions is that some of the other factors are a little squishier. So I am not necessarily going to get an invitation to go visit an investment manager onsite in the way that some consultants might.
So what are some things if you are an individual investor attempting to make good decisions about whether it’s a good time to buy a fund or not necessarily timing but whether it’s a good fund to buy or whether it’s a fund you should sell? What are the things that you should focus on if not performance and how do you do that due diligence?
Gordon: I think, things that are available in the public domain either through Morningstar or the press, you are paying attention to the stability of the investment team. Not surprisingly when teams are together they work together for a long-time. The results hopefully show in terms of good performance. The stability of the firm for whom they work is that they’ve taken over. Where are the senior people spending their time? Be aware of the fund's style and it may be undergoing some pressure on performance because that style is out of favor. And finally, one of the best predictors of performance is cost. So…
Benz: I knew you were going to say that, but our research shows that too.
Gordon: It’s absolutely all the – you know it is to the extent that an investor can keep costs low or look for the low-cost option in that particular style that actually is the best predictor and that should be a key factor in the decision as to whether or not to retain a fund or maybe switch out a fund for another fund.
Benz: Well, thank you, Catherine. Thanks for sharing your research, fascinating stuff.
Gordon: You are quite welcome, Christine.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.
