Institutional investors steer away from past performance

Watson Wyatt notes that institutional investors have been paying alpha fees for market-driven performance in recent years.
Fund managers always warn that past performance is not an indication of future performance, and a recent Watson Wyatt poll shows that only a few institutional investors think otherwise.

The survey respondents comprised of the 70 Hong Kong institutional investors û including fund trustees, sponsors and managers û who attended a recent Watson Wyatt ideas exchange conference that focused on investment beliefs that are critical to finding the right manager capable of delivering alpha or performance regardless of the direction of the market.

Naomi Denning, Watson WyattÆs head of investment consulting for Asia-Pacific, says both qualitative and quantitative factors must be used in selecting and monitoring managers rather than relying on past performance.

ôHiring and firing decisions should be supported by a decision-making process with sharp, deep and strong beliefs about their investment managers,ö she says.

One of the polls questioned the impact of asset growth on the skill level of an investment manager. Many respondents did not believe that alpha declines as assets under management increase.

ôWhile the issue of capacity varies by mandate type, the impact of capacity on a managerÆs ability to add value is not well appreciated,ö she says. ôIt is our belief that as a manager owns an increasing portion of an individual companyÆs stock they will eventually reach a limit on their potential to generate consistent alpha given the difficulties in trading without shifting prices.ö

Watson Wyatt also looked at the total fees paid by funds. Many funds only slightly believed that fees are a bigger part of a managerÆs return than generally expected. This belief can be one of the reasons why funds have been paying alpha fees for market-driven performance in recent years.

In terms of best practice investment governance, around 70% of respondents believe that manager hiring and firing success is directly related to the strength of the governance employed.

ôAlpha is a competitive activity, therefore institutions struggle to hire and fire managers successfully,ö Denning says. ôWe believe that the search for alpha requires strengthened investment fund governance because many funds are competing to find sustainable manager skill.ö
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