Trustee groups face a plethora of choice when implementing an investment offering within a pension scheme. 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 board of any football club shares the same dilemma that a trustee group faces when deciding on the fate of a manager. 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 manger, Jose would have been top of any list. Now with Chelsea lying in 17th position in the Premier League, he finds himself among the bottom quartile managers. It can happen that you’ve just employed a top active manager and he suddenly starts to underperform. How do you react?
Or here is another scenario. You have hired an up and coming active manager that has been making the headlines, impressed by his ability to speak at length about his “philosophy”. While the first year is mixed, in the second year he exceeds his benchmark beyond any level of reasonable expectation. You are on to a winner, a true superstar. But alas, the following year is one of ups and downs, ending in mid-table mediocrity. After that great year, how can you fire him for one year of underperformance?
Such was the dilemma that John W. Henry and the Liverpool FC board faced over the summer when assessing whether to keep Brendan Rodgers. They made the same decision that I believe most trustee groups would make, driven by a sense of loyalty to a manager who delivered remarkable returns the previous year. It illustrates the difficulty in determining how much of the past performance was luck and how much of it was pure skill, something that is repeatable in the future.
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 you have 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 ruthless approach when dealing with active managers.
As for Jose Mourinho, 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.” While his track record warrants continued loyalty from the Chelsea board the Russian oligarch could push the panic button if the current poor run of results continues.
Brendan Rodgers, on the other hand, is fast running out of time, his once clear philosophy appearing increasingly blurred. The attacking flare that earned him plaudits has all but disappeared, while the team’s defensive frailties seem to have only got worse. I have no doubt that Liverpool’s American owners are already talking about replacement candidates. The same goes for trustees groups, you should always have potential replacement managers lined up.
I maintain my view on Rodgers that I shared at the beginning of August:
“While I still believe in Brendan Rodgers and his philosophy, he is beginning to look a bit like the hedge fund manager touted as genius when his short subprime trade came to fruition in 2008 but who has struggled to deliver that exceptional performance since. If he fails to deliver this season, his near title success in 2013-14 will be attributed to Luis Suarez, and Brendan will be out the door. Realistically, he has ten league games to prove himself.”
My belief has waned following a couple of really dismal performances, but the same metric applies, he has ten games to prove that the team is moving in the right direction. If the next five league games resemble the first five, Liverpool fans can expect a new manager before the end of November.
Whether you are talking about football or investments, the old cliché holds true: ‘it’s a results business’.