If you are an institutional investor or consultant responsible for manager selection, and your job is to find managers that you think will outperform in the future, it may seem logical to look at those managers that have performed well in recent years. But as the adage goes, past performance is not indicative of future results.
eVestment recently conducted a study on the persistence of three-year performance for strategies within their respective universes for the 2001-2017-time period. To get a more accurate picture and minimize bias, the study included products that are actively reporting data to our database as well as those products which no longer regularly report.
One observation was that how well funds can replicate their above median three-year performance in the following three years varies from universe to universe. For example, if we look at European equity universes, nine out of 18 universes had managers consistently remaining above median in the consecutive time periods.
Investors’ reliance on performance
Across the board, performance seems to be the number one criteria by which investors look for managers. The German research firm, Insticube, found in its recent research that performance is the top criteria when sourcing managers, followed by clarity and consistency of investment process, and understanding goals and needs of clients. The same sentiment was repeated in the 2017 Scandinavian Financial Research (SFR) annual survey in Finland, which found that the top three criteria by which Finnish institutional investors evaluate an asset manager is on three-year investment performance, clarity of investment process and competitive pricing. (Disclosure: eVestment partnered with SFR for their 2017 survey to better understand the use of data amongst Finnish institutional investors and sponsored a question around the topic.)
It is understandable investors want to focus on performance as this is how portfolios are often measured. But as seen in the data above, if performance is not a reliable indicator of future success, how can institutional investors approach the manager selection process differently?
Currently, eVestment has 126 investors and consultants in Europe using our platform. Based on the aggregated usage data, European institutional investors are looking beyond performance when selecting a manager. For instance, when screening for managers in the European Equity universe, performance was only the 22nd most popular criteria to screen on in 2017, as shown in the table.
How to decide what characteristics to focus on
This data exemplifies typical screening criteria that European institutional investors use to come up with a shortlist of managers. As every search is unique, investors start the process by defining the characteristics of their ideal manager. If your goal is to find a concentrated European portfolio with a mid-cap tilt, then using screening criteria focusing on Equity Capitalization and Current Number of Holdings will get you a step closer to uncovering a suitable candidate for your mandate.
Investors utilize their investment policy and values to derive criteria to find the best fit. Principles such as manager compensation, portfolio idea generation and disciplined adherence to investment philosophy are things that helps investors guide manager search outside of performance. By translating these values into tangible data points such as measurement of style drift or percentage of employee owned, you can narrow down on criteria that matters the most to you.