It’s time to stop looking for managers who deliver alpha (return above the market) and to look instead for those with a new elusive characteristic dubbed phi, Alexander Forbes is telling trustees, retirement fund consultants and advisers.
Alexander Forbes produces an annual performance survey for the retirement fund industry, but says it is time those who pour over these surveys stopped looking for the top-performing manager in each of the categories surveyed and instead looked for a manager with the right phi, which is an acronym for purpose, habits and incentives.
Phi is a concept defined by the US-based State Street Centre for Applied Research in a paper entitled “The hidden performance variable”.
According to the latest Manager Watch Survey, a manager with the right purpose is one who is focused on the client or investor and will work with you to develop the right investment mandate to meet your investment goals.
In the case of retirement funds, the goal has often been the same for all members. But Alexander Forbes and other asset managers for retirement funds say administrators now have the technology available to consider the unique retirement goal you have, as an individual retirement fund member, taking into account how much you have saved already, your income needs in retirement and how much longer you have to save.
If a manager is genuinely focused on its investors, it should be willing to collaborate in drawing up a specific investment mandate or strategy to reach your goals, says Anne Cabot-Alletzhauser, the head of research at Alexander Forbes.
She says many asset managers present their investment mandates on a take-it-or-leave-it basis and retirement fund trustees are notorious mandate-takers.
According to State Street, the habits of a good manager should be part of a culture throughout the business of meeting your investment needs.
And when it comes to incentives, State Street says the rewards managers earn should be based on how well the manager meets your investment needs, rather than whether they achieve a performance goal.
The Manager Watch Survey quotes another article by State Street entitled “Folklore of Finance”, published in 2014. The article says the asset management industry may be profitable, but it isn’t successful. Not only does it have a low success ratio in delivering alpha, but it also fails to meet investors’ goals, which could be, in the case of a retirement fund or individual investor, to pay a pension or lump sum, avoid capital losses, meet income or cash-flow requirements or deliver inflation-beating growth.
State Street argues that the heart of the problem is how investment professionals behave and how investors assess their managers’ worth. The article says investors measure an asset manager’s performance using performance benchmarks instead of goals met, and often attribute any outperformance of these benchmarks to the manager’s skill, while blaming underperformance on the markets.
Failure to consider investors’ goals and to take responsibility for underperformance has led to investors not trusting the industry and feeling increasingly dissatisfied.
The Manager Watch Survey notes that over the past 30 years, much work has been done on what drives investment performance and how tenuous the link is between what is regarded as manager skill and the investment performance achieved.
The survey says the consequences of believing in this “folklore” is not only poor manager selection, but also destruction of value for us, as investors, when managers are hired and fired based on poor performance, irrespective of manager skill or market conditions.
The survey argues that if you have appropriate expectations of what investing can realistically achieve and employ the right strategies to achieve well-defined goals, you have a much higher probability of achieving your investment goals.
For example, Cabot-Alletzhauser says Allan Gray is a great asset manager if you have an eight-year investment horizon. Foord is another great manager if you are investing for retirement, but if you are in retirement and drawing an income, you probably want a low-volatility manager, she says.
Cabot-Alletzhauser says the State Street Centre teamed up with the Chartered Financial Analyst (CFA) Institute and surveyed the motivations of close to 7 000 CFAs working in the investment industry in 20 countries around the world.
The survey found that 92 percent of CFAs felt a level of demotivation despite the fact that they work in a highly-paid industry. Only 34 percent felt they had control over the generous rewards they could earn, Cabot-Alletzhauser says.
Some 52 percent of those surveyed said they were worried that if the investments they managed underperformed for 18 months they could get fired, and 36 percent were concerned that acting in the best interests of investors might pose a career risk.
Cabot-Alletzhauser believes that greater use of the phi criteria when engaging managers will nudge stakeholders towards behaviours, values and incentive programmes that will attract the right people to the asset management industry and have a more positive effect on what you get from your investments. [email protected]