The Fired Beat the Hired

Even large institutions and pension plans chase performance, much to their detriment. A study conducted by Amit Goyal of Emory University and Sunil Wahal of Arizona State University found that manager hiring and firing decisions made by consultants, board members and trustees were a waste of time and money.

The study, “The Selection and Termination of Investment Management Firms by Plan Sponsors,”1 reveals the negative impact of manager picking. Goyal and Wahal analyzed hiring and firing decisions made by approximately 3,700 plan sponsors, representing public and corporate pension plans, unions, foundations and endowments. Figure 5-5 shows the results of hiring 8,755 managers over a 10-year period from 1994 through 2003. Note that investment manager performance is measured by average annualized excess returns over a benchmark. The chart illustrates that managers that were hired had outperformed their benchmarks by 2.91% over the three years before being hired. However, over the following three years the managers on average underperformed their benchmarks by 0.47% per year when adjusted for management fees and transition costs. Plan sponsors often proceeded to fire managers who had underperformed in favor of other recent top performers, only to repeat the cycle again. The study concluded, “In light of such large transaction costs and positive opportunity costs, our results suggest that the termination and selection of investment managers is an exercise that is costly to plan beneficiaries.”

Figure 5-5


Using data from the same study by Goyal and Wahal, Figure 5-6 conveys the tendency for investment committees or plan sponsors to hire investment managers with a history of above-benchmark returns and fire managers with lower performance. The chart shows that after managers were hired, their post-hiring excess returns were indistinguishable from zero, and the managers that were fired performed better than the hired managers. The plan sponsors should have just bought index funds and forgotten about manager picking in the first place.

Figure 5-6

Step 5Amit GoyalSunil WahalThe Selection and Termination of Investment Management Firms by Plan Sponsors