June 19, 2007 - Hiring and Firing Investment Managers

The sponsors of retirement/endowment plans (public and corporate pension plans, unions, foundations and endowments) retain professionals to manage their funds. Do their decisions to hire and fire such professionals pan out? In other words, do their plans outperform the market after they change managers? In their May 2006 paper entitled "The Selection and Termination of Investment Management Firms by Plan Sponsors", Amit Goyal and Sunil Wahal examine this question. Using data for 8,204/910 hiring/firing decisions by 3,591 plan sponsors during 1994-2003, they conclude that:

• Plan sponsors hire investment managers after large positive excess returns during the past three years, but these new hires do not subsequently outperform the market on average. The average three-year pre-hiring (post-hiring) cumulative excess return for plans mandating investment in domestic equities is 12.0% (0.7%).
• However, for plans mandating investment in international equities, pre-hiring outperformance persists, with average three-year pre-hiring (post-hiring) cumulative excess returns of 15.5% (9.8%).
• Also, (more sophisticated?) large-plan sponsors average positive post-hiring excess returns (a cumulative 3.2% over three years).
• Average excess returns are larger for plan sponsors who retain consultants to assist with the investment manager selection process.
• Generally, the pre-firing underperformance of investment managers terminated by plan sponsors due to poor past returns is statistically insignificant. These managers subsequently generate an average three-year cumulative post-firing excess return of 4.3% elsewhere.
• A subsample of 660 matched firing/hiring decisions indicates that plan sponsors would have achieved larger excess returns on average had they not changed investment managers, even without including costs of perhaps 1%-2% for switching.

In summary, the sponsors of retirement/endowment plans show little timing ability in hiring and firing investment managers. There is some evidence that more sophisticated sponsors (of large plans and of plans that invest internationally) make better decisions.

Results suggest that individual investors in mutual/hedge funds should consider more than just recent past returns in making decisions to switch funds.

For related research, see Blog Synthesis: The Wisdom of Analysts, Experts and Gurus and Blog Synthesis: Mutual Funds and Hedge Funds.