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Aon Retirement and Investment Blog

Know Your Managers

The “Oracle of Omaha,” Mr. Buffet, penned in his 2001 Chairman’s Letter “you only find out who is swimming naked when the tide goes out.” While the tide did not go out in 2015 as it did in 2001, or more recently 2008, 2015 was characterized by bouts of volatility, narrow stock leadership (where a small minority of stocks is responsible for most of the market gains; see chart) and some wide divergences between indices and sub-components of indices, all of which contributed to performance outcomes. In some instances the wide divergence among sectors or sub-asset classes was a contributing factor to the underperformance (yes it could apply to outperformance but outperformance is not a worry to investors and the tenet of this blog post is not to terminate a manager for underperformance if it consistent with how they invest) among active managers and their respective benchmarks. Some of the noticeable divergences that we witnessed in 2015 were as follows: 

  • The Russell 1000 Growth Index rose 5.7%, while the Russell 1000 Value Index declined by 3.8%,  a divergence of 9.5%
  • The S&P 500 Energy sector plummeted 21%, while consumer discretionary stocks climbed 10%, a 31% difference
  • The MSCI Emerging Markets Index slid 15% and underperformed the MSCI EAFE Index (+1%) by 16%
  • U.S. Treasuries rose by 0.8% while the Barclays High Yield Index fell by 4.5%

Source: Factset, INTECH
This preamble brings me to my main point; it is a good practice to regularly remind ourselves about the manager’s philosophy and investment process, not just the performance results. During quarterly investment committee meetings a certain amount of time is spent discussing what drove the outperformance or underperformance of the managers against benchmarks. While that discussion may center on individual stocks, performance is also due to the manager’s investment philosophy and process, and this needs to be considered when assessing performance. Indeed, as a result of philosophy and process, a manager may have a structural overweight or underweight to certain sectors that will drive the performance outcome. For instance, value mangers may seek out companies that are currently out of favor, such as energy stocks in 2015. Due to the dramatic performance dispersion some managers have had a high degree of underperformance relative to the index. 
By way of another example, in this low yield environment many “core-plus” bond managers have held high allocations to High Yield, which is not part of the Barclays U.S. Aggregate Index. While that top bond manager may have been first quartile the last five or ten years they may have suddenly shifted to the bottom quartile or worse (see chart) as a result of their exposure to the high yield segment of the market.  

Source: eVestment

Diamond represents a manager within the Core Plus Fixed Income Universe. 
Chart shows peer ranking quartiles where 1=best and 100= worst
In some instances there is turnover with committee members, in other instances, the manager may have been hired so long ago that you don’t recall their historical biases. Additionally, we realize that active managers will likely go through periods of underperformance due to structural style biases. In judging a manager’s performance, we can (for example) compare them against a style benchmark to assess whether they are adding value against a simple (and cheaper to implement) factor approach. Therefore it is a good idea for committee members to re-familiarize themselves with the philosophy and process for each of the managers within the plan. As long as the managers have consistently applied their process and philosophy, a period of underperformance, especially in instances where there is a wide divergence amongst indices, should not be cause alone to replace a manager.
Brian Binkley is Senior Consultant with Aon Hewitt Investment Consulting based in Norwalk. 
The information contained above should be regarded as general information only. That is, your personal objectives, needs or financial situation were not taken into account when preparing this information. Accordingly, you should consider the appropriateness of acting on this information, particularly in the context of your own objectives, financial situation and needs. Nothing in this document should be treated as an authoritative statement of the law on any particular issue or specific case, nor should it be treated as investment advice. Use of, or reliance upon any information in this post is at your sole discretion. It should not be construed as legal or investment advice. Please consult with your independent professional for any such advice. The blog content is intended for professional investors only.

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