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Why Do Institutional Plan Sponsors Hire and Fire their Investment Managers?
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Abstract
This paper examines the investment allocation decisions of pension plans, endowments, foundations, and other
institutional plan sponsors. The experience and education of plan sponsors and the environment (both regulatory
and agency) of the institutional market suggests that institutional investors rely less on past performance and use
diffe rent criteria when evaluating performance compared to mutual fund investors. Institutional investors are
expected to be less concerned with total returns and more considerate of benchmark-adjusted excess returns, and the
consistency with which they are delivered, over longer time horizons. An examination of asset and account flows
for actively-managed U.S. equity products is largely consistent with these expectations. The consistency with which
managers deliver positive or negative active returns relative to the S&P500 over multiple horizons, without regard to
the magnitude of these returns, plays a key role in determining the flow of assets among investment products. Style
benchmarks play a larger role in determining account movements, which is found to employ more criteria than asset
moves. However, total return is also considered, as the magnitudes of a one-year loss and 3 and 5-year total returns
are found to be incremental factors in plan sponsors’ allocation decisions. One explanation for this result is the
principal-agent arrangement faced by plan sponsors. Although the sponsors may be more sophisticated than the
typical retail investor, their clients, investors and the investment board, may not be. Plan sponsors may minimize
job risk by hiring and firing managers based on excess returns with incremental allocations based on total returns,
thereby satisfying both their mandate and their clients. It is also found that smaller and older products capture
relatively greater flows.pension plans, endowments, foundations