Is Manager Selection Worth the Effort for Advisors?

“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.

—Related on ThinkAdvisor:

• Morningstar’s Fund Managers of the Year: 2017
• What Should Really Guide Your Investment Thinking in 2018