Choosing an Investment Manager: Would You Have Fired Warren Buffett?
When should you think about firing your investment manager? There are many differences of opinion. Some suggest it makes sense to consider choosing a different investment manager after three years of underperformance. Although sometimes it makes sense to make changes at that time, it’s important to be sure that you’re not firing the next Warren Buffett.
According to Towers Watson, a leading investment consulting firm, the Oracle of Omaha has had two 3-year rolling periods of relative underperformance in his 45-year history of investing. These returns would no doubt have resulted in lost clients — to the clients’ own ultimate chagrin because his long-term track record shows that he has created extraordinary value.
Is It OK To Fire a Manager For Underperformance?
Underperformance is the leading cause of manager firings, but it’s not clear that firing managers for underperformance is a good idea. If the primary portfolio manager has changed or portfolio turnover has risen without good reason, the underperformance may be simply a reflection of a broader market decline or the investment style of the new manager.
It may be prudent to wait and watch. Always ask: are the results consistent with the manager’s stated investment process and skill? If the answer is yes, it may be premature to fire anyone.
With that said, it is always worth digging more deeply. You may want to take a long, hard look — or make a visit to your investment adviser — if
- the manager aggressively shifts total portfolio risk around in a manner that makes you uncomfortable,
- you notice the manager “window-dressing” the portfolio at period ends, or
- the manager announces any change to the investment process that you find unsettling.
Organizational issues at the firm are another popular reason to fire an investment manager. Key employee turnover — particularly if it affects the portfolio management of your account — regulatory issues, and increasing operational risk are good reasons to seriously consider firing an investment management firm.
In many cases, investors fire their managers for reasons that mostly boil down to their own feelings. Feeling fed up or anxious is not a good enough reason to justify leaving a manager.
To test yourself, read the book by Michael Lewis titled The Big Short. Then ask yourself, Would you have had the fortitude to hang on through the tough times with quirky portfolio managers in order to ultimately realize outstanding investment performance? Being a good client is just as important to your long-term investment performance as having a good money manager.
Before making a decision to fire a manager, you may want to get advice from others. There are lots of opinions about what makes a good money manager and when to fire managers. Very few of these opinions, however, have facts or proof to support them.
Professional advisers seem to be in the best position to offer independent and sound advice, but be careful. They too may have opinions unsupported by any proof other than a few colorful anecdotes. They may also have close relationships with other managers that may affect their thinking about the quality of your manager.
Finally, a cautionary note: The academic evidence suggests that even sophisticated institutional investors struggle with hiring money managers who can outperform. In fact, a recent study of over 1,000 funds found that they hired managers who had much stronger performance than the ones they fired but that the newly hired managers underperformed, on average, the fired managers. This sounds a lot like buying high and selling low, which is, of course, the opposite of what you are trying to do.
Firing a manager and then rehiring him at a later date is another hazard that happens more frequently than you think and helps to erode overall investment returns over time.
Just imagine if you had moved your investments away from Berkshire Hathaway after one of those periods of underperformance. Just like any other investment decision, when firing an investment manager, it’s very important to have a sound basis for the firing and a plan for what to do next. Consider these questions:
- How much volatility in a manager’s results are you prepared to endure?
- Are you prepared for the new manager to underperform in the short run?
Get the facts about the people who are managing your money and the process they are using, and ask for proof of how they contribute to performance.
Amit Goyal and Sunil Wahal, “The Selection and Termination of Investment Management Firms by Plan Sponsors,” Journal of Finance, vol. 63, no.4 (August 2008):1805–1847.
Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.
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