Investing

Process for Terminating Investment Managers Is Important

While much time is spent selecting investment managers, not nearly enough time is spent in establishing a processing for terminating such managers, says a recent paper from the Strategic Investment Group.

By Kevin McGuinness editors@strategic-i.com | August 06, 2014
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“The Art and Science of Manager Termination” looks at reasons retirement plan sponsors may want to terminate investment managers and offers investment committees criteria by which they can evaluate the underperformance of investment managers.

There are many sound and valid reasons to terminate and replace an investment manager, once the facts have been properly analyzed and considered, says the paper. These reasons can apply similarly or differently for defined benefit (DB) or defined contribution (DC) plans, says Ronald Klotter, managing director of the Arlington, Virginia-based Strategic Investment Group. These reasons can include:

  • Adverse organizational change. An investment manager handing off their investment management duties to more junior staff, high turnover in the research staff, or instability within key management are all elements to consider. “How these organizational changes are dealt with by both DB and DC plans are probably very similar,” Klotter tells PLANADVISER, “with the plan sponsor or investment committee still having a duty to oversee these managers and their performance.”
  • Unfavorable market conditions. If a plan sponsor or investment committee believes a future market environment will be inhospitable for a manager’s strategy for an extended period, they may want to consider terminating the manager, even if the strategy is otherwise sound.
  • Redundancy or irrelevancy. Manager terminations may be initiated if it becomes apparent that their strategy is no longer needed or able to fulfill its role. This reason is less of a factor with DC plans, says Klotter, since investment options are usually structured to be there for specific reasons, with alternative options being offered to participants, such as passive and active investments.
  • Failure to meet return expectations. Every manager must meet return expectations. In determining whether or not to terminate, plan sponsors or investment committees should investigate and answer why a manager did not meet those expectations. It also helps for plan sponsors and investment committees to have clear criteria for return expectations and for monitoring managers, says Klotter. Communications can also be a factor, he says, with DC plans disclosing this information to participants, while DB plans would not be required to do so.
  • Fiduciary, ethical or operational risks. In this area, plan sponsors and investment committees need to look at operational risks and whether the manager has a poor control environment. However, if lapses by the manager are found to be due to an underlying ethical problem or a lack of timely action, that may prompt immediate termination. Fiduciary concerns are important, says Klotter, regardless of whether the plan is DB or DC in design.