Is manager selection a thankless task for financial advisors?

A new article from Research Affiliates — “Is Manager Selection Worth the Effort for Financial Advisors?” by John West and Trevor Schuesler — examines if the resources financial advisors are allocating to manager selection add value to their clients’ and their own bottom lines.

According to the article, manager selection is the most commonly marketed service by financial advisors. West and Schuesler looked at what services the Forbes top 100 financial advisor firms offer and how they staff those services.

The pair found that manager selection was listed by 39 firms in their Form ADV Part 2 brochures, with an average of more than four employees per firm participating in the activity.

By comparison, the second most commonly cited service is asset allocation, offered by 28 firms, but with less than half as many employees participating.

“Today, manager selection is the top service advisors market to clients, and the process required to provide the service claims a meaningful amount of a firm’s resources,” the article states.

So, is this an efficient allocation of resources or misappropriation of an advisor’s time?

The article suggests advisors “carefully and honestly” assess manager selection via the impact–effort matrix. Although, the article admits that the determination of whether manager selection falls into the category of a “low–impact/high–effort thankless task” comes down to expectations.

“If the expectation is to reduce negative alpha or minimize regret risk, manager selection will likely have a positive impact, perhaps even enough to justify the resources commensurate with the task’s difficulty,” the article states. “If the expectation is to produce positive alpha, financial advisors and their clients are likely to be disappointed.”

According to the article, academic literature shows manager selection fails to produce positive excess returns, on average. This can result in what the article calls a “hamster wheel” of manager selection, or continuously replacing poor performers with good performers.

Recent research finds that, when measured by trailing three-year performance from 1994 through 2015, top-decile managers underperformed the bottom-decile managers by 2.3% a year. 

“The evidence makes it pretty clear we shouldn’t use historical performance as our primary manager selection criteria,” the article states. 

The article does note several benefits to “careful and well-resourced manager selection.”

“[B]enefits of a well-documented manager research effort can satisfy certain statutory regulations such as ERISA, mitigate regret risk in performance ‘blow-ups’ (particularly with negative press headlines for public entities), and/or provide a layer of — real or perceived — fiduciary insurance (i.e., by performing an extensive due diligence review before recommending a manager, the advisor or consultant best positions themselves to explain a poor-performing manager),” the article states.

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