PLANSPONSOR - June/July 2019 - 43

20 years. We knew how to describe what
we did, and we had the track record, but I
had no idea of what the link was between
the two. We could see that even when
we were getting the right results in the
portfolios, our decisions on selling stocks
were appalling, " he recalls. " In the early
'90s we started to build these analytics to
see if we were as bad as we thought. And
we were-and worse. "
The Inalytics quantitative engine
analyzes both managers' positions and
trades, Di Mascio explains. " The buying
decisions are very instructive, on whether
managers are able or not to find winners
and add them to their portfolios. And our
original research showed that poorly timed
selling decisions were losing 100 basis
points [bps] per annum. From the perspective
of the asset owner, that can be as much
as twice the manager's annual fee. "
Unfortunately, most DC plans lack
the budget to access Inalytics' services,
but they can benefit from the logic and
approach and inquire into their managers'
trading acumen.
Consultants point out, however, that
number-crunching is just the start. " Our
process is more qualitative and personaltouch, "
Gardner says. " If we can't figure
out how a manager achieved excess returns
above the benchmark in every period, or
why they chose to over- or underweight
certain sectors or stocks, sometimes it's
better to move on to a different strategy. "
For target-date funds (TDFs),
Deckman expands her analysis, as well.
" We are sensitive to the possibility that
participants will abandon a fund, and
we want to know what sort of ride they're
likely to get. I want to know the equity ratio
at the end and whether the risk reduction
path is steep or gradual. I want to think
about that in terms of the 'personality' of
the workforce the fund will be serving-
for instance, Millennials who probably
aren't saving as much as they should, or
a manufacturing force who will leave the
minute they can. "
Willis Towers Watson has quantified
the qualitative aspects of selection into
six sets of criteria that consider, among
other things, the number and caliber of
a manager's investment team, approaches
to portfolio and risk management, likely
impact of firm growth on their strategies
and appropriate levels of fees.
These set the bar high. " I can't think
of any manager among those top rated
who doesn't have some sort of challenge, "
says Jason Shapiro, senior investment
consultant at the firm, in New York City.
" A lot of boutique managers have top-notch
insights, but they might be challenged in
building their portfolios as they grow. Or a
very large manager can have good people
and risk management, but there might be
issues with finding enough capacity in the
markets they're investing in. "
A Clinical Approach
While hiring a manager may be a long and
winding process of getting to know a new
firm, firing is a more clinical one, though
it, too, starts with fund returns. " We track
performance and its consistency, but
we tend to be conservative, meaning we
recognize that good managers can underperform
for a quarter or two, or their style
can be out of favor for a period of time, "
says Gardner. " We're not quick to terminate
based on a couple of bad quarters. "
Consultants agree that four quarters
of disappointing marks calls for
some sort of action. " We won't leave a
manager on our watch list in perpetuity, "
Gardner notes. " We have a soft internal
rule that once a manager has reached
four quarters of watch status, they either
need to come off watch or go to a 'maintain'
status or be terminated. That's what
our clients pay us for. "
Disruptions beyond those related to
performance-e.g., the departure of a star
portfolio manager or team, or a drastic
change in a manager's avowed style in
apparent response to challenging market
conditions-may call for swifter action.
Shapiro says proper monitoring starts
at the beginning of a relationship with a
manager and not just after results start
to slip. " We recommend that our clients
" ... once a
manager has
reached four
quarters of
watch status,
they either
need to come
off watch or go
to a 'maintain'
status or be
terminated. "
document why they have picked a manager,
setting realistic targets for risk and return
and tracking error against benchmarks.
There also should be a reasonable time
frame for achieving those, perhaps three to
five years. Managers who are more active
in their styles should generate higher
returns over the long term, but by their
nature they will also show greater underperformance.
It goes both ways. "
" Hiring managers is getting harder, "
Deckman observes. " It used to be clients
had an expectation for active management
for all investment styles. Today we
really need to explain what value an active
manager is going to add and what's going
to be different from just going passive.
Whether it's due to the long bull market
and strength of indexes or the fixation on
fees and lawsuits, sponsors are expecting
stronger justifications from advisers than
they might have five or 10 years ago. "
" It's harder today and more cyclical, "
echoes Shapiro. " But for those sponsors
that still have faith in active management,
it's a matter of staying grounded in their
fundamental beliefs. Over the long term,
their expectations haven't changed, but
the path to get there may be more volatile. "
-John Keefe
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