Our previous post demonstrated that research on institutional managers suggests that the same sort of performance-chasing manager-switching that hurts individual investors also hurts the performance of institutional investors.
Based on the conclusion that this switching of managers has led to demonstrably unsatisfactory results, the natural questions that follow might be, "What is the alternative?" and "When should you change managers, then?"
We would argue that the results of the separate studies that we have cited argue for investing directly with a money manager, and not relying on the advice of a third-party who is not a money manager but rather "hires and fires" money managers. The other alternative is to manage the money yourself, but many people do not have the time or inclination to do that, and when they are investing substantial amounts the cost of mistakes can be significant.
We have long advocated finding a money manager who has a consistent investment process and has been using that investment process for a period of many years, and has an infrastructure around him, but who isn't too big. We believe that a manager's level of investment in his own portfolios is also an important indicator (he should "eat his own cooking").
The results of the studies that we have cited in previous posts suggest that investors should not be hasty in abandoning a manager if they have carefully examined his process for fundamental soundness and for consistency of execution.
We pointed out in an essay entitled "What hasty investors could learn from an Ent" that there is a helpful metaphor from Tolkien's famously un-hasty characters in the Lord of the Rings. A longer "time perspective" is helpful when evaluating the market movements of businesses or of portfolios composed of the stocks and bonds of businesses. The day-to-day gyrations of the markets cause many investors to focus on a much shorter time frame than they should.
Other research demonstrates that underperformance by a manager for periods as long as three years do not necessarily indicate that an investor should fire that manager. A study published in 2006 and authored by Baie Netzer and Melissa Wedel of Litman/Gregory found that almost every manager who outperformed over a ten year period trailed his benchmark for three years by a percentage of 2% or greater at some point during those ten years.
But the average investor, who holds onto a manager for a period shorter than three years, would probably abandon a manager after a couple years of underperformance. This is where the motto, "Do not be hasty," becomes important. To the average investor, waiting as long as three years does not seem to be "hasty," but in fact it may take longer than that for a portfolio manager's companies' potential to be realized, which is why the Ent metaphor is so appropriate.
However, there remains the fact that it is appropriate to leave a manager for valid reasons. The fact that most people hurt themselves by switching too often does not mean that investors should be blind or obstinate (as we explained regarding actual stocks in an earlier post).
One valid reason for leaving a portfolio manager is if the portfolio becomes too big. Successful money management attracts more new dollars, and when the flow of new assets becomes an avalanche, the very size of the portfolio can cause the investment process to change. You can see this very process graphically illustrated in the history of the Fidelity Magellan fund, which we wrote about in this post.
Another reason to leave a portfolio is if the manager himself leaves. If you have evaluated a manager's process and the consistency with which he applies that process, then when he leaves the basis for your evaluation of those factors has changed. Money manager turnover industry-wide is actually much higher than most investors may realize. An S&P research study in 2007 found the average portfolio manager tenure to be only 5.6 years.
Certainly, any indication of a lack of integrity would be cause to leave a manager.
While there are valid reasons to change managers, research indicates that most investors would do well to be less hasty in doing so.
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