PLANSPONSOR - November/December 2017 - 59

bull market is over eight-and-a-half years
long. From peak to peak, or trough to
trough, would be the ideal way to measure
performance. "
Rising stock prices notwithstanding,
the current market regime has stressed
the relationships between sponsors and
their active managers. Over the fiveyear
period ended this June 30, 82%
of managers of large cap U.S. equity
portfolios underperformed their benchmarks,
and, among managers of small
cap stocks, 94% fell short, according to
the mid-year 2017 SPIVA U.S. Scorecard,
compiled by S&P [Standard & Poor's] Dow
Jones Indices.
Breaking up is also complicated
across manager styles. Twenty-plus years
of study by financial economists point to a
value style having a consistent advantage
over the long run, but, DeForrest notes,
" one of the largest challenges for us is to
explain how much growth has outperformed
value. That is readily apparent in
the U.S. equity market but not as much
in the international markets, where a
number of really good international value
equity managers have struggled for the
last three to five years, " he says. " To the
extent that a plan has an active manager
in both growth and value, we certainly
want it to remain patient with the value
manager, who has had more of a headwind
than the growth manager. "
Many sponsors have investment
and manager decision criteria spelled
out in their plan's investment policy
statement (IPS), but consultants and
other advisers counsel against drafting
and interpreting these documents too
strictly. " Often a statement will say, 'The
committee shall use these criteria, and
if the fund doesn't meet the criteria for
two quarters, the fund shall be placed on
the watch list, and if it is on the watch
list for two quarters it shall be replaced,' "
says Bruce Ashton, a partner in the Los
Angeles office of law firm Drinker Biddle
& Reath LLP. " 'Shall' is such a strong
word-the policy statement should be a
road map for the committee, rather than
a set of handcuffs. "
In practice, the decision to remove a
fund from a lineup can be driven by a plan
committee acting either through its IPS,
a consultant's manager rating system, or
a consultant's judgment and experience.
" In my experience, the right answer is all
of the above, " says Loughlin. " Sponsors
can make bad decisions from prescriptive
policies, so judgment, patience and an
understanding of the market cycle need
to be involved. "
Materiality is another consideration,
she adds. " I use the example of a bond
manager who underperforms by modest
amounts. Does the sponsor commission
and pay for a search for a replacement?
More and more sponsors want to interview
their managers, and there is a cost
to that. And the larger the plan, the more
likely it is to have separate accounts in
white label arrangements, and those can
entail the cost of a portfolio transition.
There are a host of frictional costs, even
before you get to the cost of communicating
with participants. "
Heartbreaking performance may
bring about a manager firing, but, when
it comes to finding a replacement, consultants
suggest an approach that contemplates
the economic logic of a firm's investment
process as well as the cold numbers
of a performance record. " What you're
looking for is a manager that will work
well over time, rather than a recent top
performer, " says Fannin. " Be conscious of
reversion to the mean, because picking a
manager on top recent performance alone
could set up a plan for failure. "
KEY POINTS
* Having to replace a fund that has not delivered on expectations,
and then settling on a capable replacement, can be a difficult task
for plan sponsors.
* Experts suggest that a plan's investment policy statement not be too
directive as to when a plan should watch or replace a fund.
* Most fund managers are hired and fired based on the numbers,
but the fund's asset class and the market environment, among other
factors, should also come into play.
PLANSPONSOR.com November-December 2017 59
" There are valuable lessons to be
learned when a manager has missed his
targets-[i.e., to be learned] in identifying
something in the investment process
that wasn't working for the investment
program, " Loughlin says. " For example,
in the current cycle, some of the bestperforming
growth funds are those that
own the 'FANG' [Facebook, Amazon,
Netflix and Google] stocks. Those portfolios
may be less efficient in terms of
Sharpe ratio, but, through taking greater
risk, they may have outperformed. "
" Moreover, " she adds, " if a plan is
populated with Millennials, is participant-driven
and has a growth fund that
doesn't invest in those sectors, not only
might the sponsor be missing a return
opportunity, it might also be missing
where participants want to invest. "
Similarly, Loughlin explains, large
cap U.S. stocks have shown negative
returns in only two quarters over the last
five years; therefore, managers sticking to
a low-beta style have probably been underperforming.
Instead of summarily firing
the manager, she says, a sponsor should
ask questions and be sure it fully understands
the nature of the fund.
" There is a passion that many in the
industry have about active managers, "
Loughlin observes. " The 'easy button'
is to replace one who is performing
poorly with an index fund, or with an
active fund that's been doing better. But,
at this point in the cycle, those can be
poor decisions to make. Don't confuse a
bull market, or an index fund, with brilliance. "
-John Keefe
http://www.PLANSPONSOR.com
PLANSPONSOR - November/December 2017

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