When an institutional investor launches a call for tenders to specialized managers, for the management of part of his assets, he will consider several criteria, the quality of the delegated company, the expertise of the manager and his past performance, but also the legal aspects and the proposed management costs. He will be able to call on a consultant to lead this project and be helped in his choice. Other criteria may sometimes come into play, such as the personal knowledge of the principal and in particular his relations with managers of potential agents. What is the situation in practice and what are the ex-post consequences of these relations?
In their article entitled “Choosing Investment Managers” Amit Goyal (from the University of Lausanne and the Swiss Finance Institute), Sunil Wahal, and Deniz Yavuz analyze the approximately seven thousand calls for tenders for pension fund management registered between 2002 and 2017 on the US and ex-US markets and listed in two databases (FundMap and eVestment). These list the consultant if there is one (very common case in the US), the candidates, on average 90, the finalists, on average three, the finalist and, for the last three, their performance over the three years preceding the call for tenders. The researchers also highlight the potential relationships between the leaders of the mandating institution and those of the competing asset managers as well as those of the consultants, thanks to another database (Relationship Science) explaining all the official mandates within companies, associations, or foundations.
Given the average number of competitors, the probability of choosing one is on average 1.1%, without further information. When an official relationship is identified, this probability increases by 0.72%, or 65% more. The probability increases only slightly in the case of a relationship between the asset manager and the consultant, on average 0.14%. The premium to the size of the assets under management of the potential agent is significant since the probability increases by 0.48%. It is therefore undeniable that relationships, at least those known publicly, have an influence on choice, but these are obviously not the only criterion.
The past performance of the finalists indicates that the winner’s performance is better, especially in distant past years. On the other hand, the future performance of the funds who are hired and have “connections” turns out to be less good than those of the other funds who are hired, of the order of 0.30 to 0.40% per year. But above all, the performance of funds who are hired and have a “connection” compared to the average of the other funds who are hired but without connections is much lower, about −0.8% per year. These under-performances are even more pronounced, at −1.1% for public institutions. Connections with consultants also have a negative effect on performance, in the order of −0.6%.
Thus, in the world’s largest asset management market, it appears that, provided they are identical, institutional investors prefer, quite distinctly, managers whom they know personally. This preference turns out to have no positive
a negative impact on future performance, all other things being equal, especially compared to those who were not finalists! The reasons given by the authors are numerous and revolve around behavioral biases, including cognitive, familiarity or crony biases. But why, having noted lower performance (mandates generally lasting 3 years and the period being long of more than 6 mandates) would American pension funds, especially public ones, continue to favor their “relations”? Is it by a feeling of comfort, a kind of an assurance, or is it for other unknown or less confessable reasons?
These results are reminiscent of other cognitive biases, country preference for example, or the influence of “cronyism” in boards of directors, with also negative effects on performance. It is almost certain that such influences exist in other markets, in Europe or in emerging countries. This study is also reminiscent of the results of the authors of “The folly of firing past poor performers”: is the three-year period chosen for these competitions the most relevant regarding performance skills? It seems decidedly to have perverse effects, with relationships or without!
This article is written by Jean-François Boulier, Member of the Board and Chairman of the Inquire Europe Prize Committee