Hiring High, Firing Low

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Many years ago, when equity mutual funds were having a tough time finding investors, I attended a conference sponsored by a brokerage firm.  Times were tough then, in the dawn of the Eighties, and the mutual fund companies brought out their star's to help stir up some activity, hopefully on the buy side.  One of the speakers impressed me enough to investigate his organization.  This organization turned out to be The American Funds, which is the mutual fund division of The Capital Group Companies, Inc.

It was during this investigation that I came across the writings of Robert "Bob" Kirby, the head of Capital's institutional division, The Capital Guardian Trust Company.   A number of years later I had an opportunity to listen to Mr. Kirby deliver a presentation.  Given the opportunity to meet the man I made a point to introduce myself to him.  Granted, this meeting took about five seconds, but sometimes five seconds is all that is needed to make a lasting impression.

Maybe this impression stemmed from our shared thrill of speed; Mr. Kirby raced sports cars.  Or perhaps I was just a star struck young man.  Whatever it was, it was enough to place him on my list of mentors.  Mr. Kirby is no longer with us, but his writings are.  Institutional Investor printed one of these writings in May of 1988.  More than twenty years after it was originally written, I find it still as applicable as ever, and well worth sharing with you.   May of 1988 was just a few months past the 87 stock market crash.  Today we are just a few months past the terrible springtime market.  Given the number of people today who find themselves shuffling money from one place to another it is not only appropriate, but timely.  Here it is.

Hiring High, Firing Low

In looking at. . .{1987 investment performance}-in particular at the list of 1987's "losers" of pension fund business-it is very disturbing, but not al all surprising, to see among those losers many firms that were among the big winners only a few years ago.  It gives one the strong impression that a substantial portion of the pension fund management business has become a slightly modified form of Russian roulette.  Apparently, underperforming the market (even modestly) for three or four years is cause for dismissal of a money manager in the eyes of many.  If true, then it is not a case of "whether" but "when" the day comes that every manager pulls the trigger and finds a real live bullet in the chamber.

The pension fund management business in its present form is, admittedly, relatively young (it is still shy of its twentieth birthday), but it seems to me high time that those involved in the administration of major pension funds should begin to realize that markets make money managers-not vice versa.  Any money manager who develops a logical approach based on a modicum of common sense and who applies that approach with a fair degree of consistency (and, sadly, even a few others who don't) will sooner or later encounter a market that makes him look like a genius for a couple of years.  Just as certainly, he will also encounter markets that make him look like an absolute boob.

How can anyone believe that organizations like T. Rowe Rice or Pioneering Management or individual investors like Dean LeBaron would suddenly wake up one morning and be dumb?  If you believe that this is possible, I daresay that sooner or later Peter Lynch, John Neff and even Warren Buffett will someday wake up dumb.  I do not know a great deal about some of the organizations that lost a number of clients, but I daresay they are no smarter or dumber today than they were three or four or five years ago when they were the winners. . .

Major corporations and their pension fund consultants go through a prolonged and elaborate ritual in the process of selecting money managers.  Pretty clearly, however, the single criterion on which at least 80 percent of the selection decision is based is the manager's investment performance during the prior three years.  If all you had to do to achieve successful pension fund management was to hire the firm with the best three-year record, wouldn't all bad managers be out of business?  Instead, it seems to me that there is more hiring and firing of money managers today than there ever has been.  Why? 

Moving in Tandem

There is a fairly widespread and possibly growing belief out there in pensionland that size is one of the problems.  However, I believe that this would be very difficult to prove scientifically.  In 1988 and in years past, some of the . . . winners have been large firms, while many of the losers have had only moderate assets under management.  From personal experience, I would not be inclined to blame size itself.  I would be more concerned with rate of growth.  Everyone hires the same money managers (the ones with the great three-year records) at the same time.  An organization grows from ten clients to 25 clients and from $200 million to $1 billion under management in one year.  I can testify that it is not easy to build and maintain a stable organization and a consistent decision-making structure under those circumstances.

I am just as confused as everyone else when it comes to determining how to differentiate luck from skill when reviewing the results of a money manager.  However, I am quite sure that while an intense focus on the investment results over the past 36 months may not be totally irrelevant, it is damn close.

I have been asked a number of times what I would do if I had responsibility for hiring a money manager.  My response has always been the same.  I would go through the procedure that a company uses in selecting a law firm, a medical clinic or accountants.  Find an organization of quality people with integrity, experience and dedication that is respected by its clients.  When you have identified all the money management organizations that meet those specifications, hire the one that has had the worst investment performance over the past two to three years.  The . . . [recent] list of "losers" probably represents a very good place to go looking for a money manager.

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Institutional Investor (May 1988), p. 29 New York:  Institutional Investor, Inc.

I wanted to share Mr. Kirby's words with you, not in an attempt to compensate for our performance over the past year, as it was far from the worst and quite respectable given all that has happened.  No, I wanted to share his words with you because of the amount of pressure you will face from the army of sales people currently facing "Career Risk".  Most of you know, and if you don't you need to know, that over the past year the number of financial professionals that have changed employers has increased.   When many of the major banking institutions folded or merged into another bank, it not only opened the door, but forced many financial advisors to change firms.  Some of the more productive financial advisors were paid "signing bonuses" that were dependent upon the total new revenues they brought into the firm, over the course of their first year and beyond.  A good financial salesman knows that one of the best times of the year to encourage a change is when the calendar rolls over to the new year.  Having a new boss, without the baggage of poor past performance, they are free to hit you hard with the latest and greatest investments available.  So put your guard up for the mailers, the phone calls and your circle of friends and relatives who have already taken the bait.

Until next time,

Kendall J. Anderson, CFA