Trustee groups I work with face a plethora of choice when implementing an investment strategy. One important decision is whether to use passive or active investment managers. Passive managers simply look to replicate a particular index. For example, for broad exposure to global equities, trustees could use a low cost passive fund to replicate the performance of the FTSE World equity index, a global equity index of over 2,500 companies.
Active funds, on the other hand, aim to outperform their benchmark index, for a much higher fee of course. Active investment managers are skilled at building the case for why they can do what very few active managers can do, deliver persistent outperformance. In football parlance, you are looking for a Sir Alex Ferguson of the investment industry, a one-firm manager that can consistently deliver. They are not easy to find!
The fact that a Sir Alex exists – Warren Buffet comes to mind – is the very reason that investors are attracted to active management. Despite the higher fees and the fact that most active managers fail to consistently outperform their benchmark, investors want to chase the dream of finding that “one”. Maybe it is because of our human spirit or maybe it is just our innate desire to take our chances rather than settling for a more certain outcome.
While finding and selecting the right active manager is in itself a challenge, trustee groups must also consider the extra level of responsibility they take on when employing an active manager, particularly in terms of monitoring performance. If a passive manager fails to replicate the benchmark, then a decision can be made quickly to fire them. However, periods of underperformance for an active fund, which are common, require a much more in-depth analysis of what is behind it and most importantly is it likely to continue? Not an easy thing considering the difficulty in predicting the future.
Therefore, it is crucial to have a clear sell discipline in place to avoid hastily firing an active manager or holding on for too long in the hope that the good times will return. Remember, Sir Alex Ferguson came very close to being fired in the early days at Manchester United, what might have been!
The dilemma that a trustee group faces when deciding on the fate of an underperforming manager is not too different from that faced by board of a football club on a poor run of form. Take Jose Mourinho at Chelsea FC for instance, the self-proclaimed ‘special one’, and arguably one of the greatest managers in the game. At the beginning of the season, if a club was picking a manager Jose would have been top of any list. Now with Chelsea lying in 16th position in the Premier League, he finds himself among the bottom quartile managers.
Similarly, as a trustee group it can happen that you’ve just employed a top active manager and he suddenly starts to underperform. How do you react? These are the types of decisions that await a trustee group when they hire an active manager. I am not advocating against active management, I am merely pointing out the extra complexity that is added to the monitoring responsibilities when employing active managers.
Deciding to fire a manager is always more difficult than hiring a manager. It is viewed as confirmation of your own poor decision to hire the manager in the first place, something people want to avoid as much as possible. However, it is important to address this behavioural bias head on, otherwise it can foster paralysis in the decision making process.
The prospect of firing an active manager is just something one has to accept. As Gordon Gekko, the iconic character from the 1987 movie Wall Street, said “you win a few, you lose a few, but you keep on fighting. If you need a friend get a dog”. Such is the mantra of the active fund manager, and trustee groups must adopt a similar calculated approach when dealing with active managers. Don’t be afraid to fire a manager when the warning signs present themselves.
As for Jose Mourinho, his track record of winning trophies might warrant continued loyalty from the Chelsea board but his behaviour continues to depict a man who has lost control. While the extent of the capitulation has been surprising there was the odd red flag that not all was well at Chelsea. As I wrote before the season began, “Mourinho has always been a provocative character, but his latest rants portray the insecurities and paranoia of a man that could be purged at any moment.” The Russian oligarch owner, Roman Abramovich, is now close to sacking Mourinho for a second time.
Whether it is football or investments, the old cliché holds: ‘it’s a results business’. Of course, the time you give a manager to demonstrate those results is also a serious consideration. In both the football world and the investment world, that time frame is becoming ever shorter.
Therefore, if one decides to employ an active manager it is crucial to have a clear process in place, for the consistent evaluation, selection and monitoring of managers. Remember, having a winning investment strategy does not mean being right on every investment. The goal is to have more winners than losers. At Manchester United, Sir Alex Ferguson’s win percentage was just under 60%. The only difference in the investment world is that the magnitude of those wins and losses has much more significance. Hence, the importance of diversification. But that’s a discussion for another day.