Many investment managers like to say that they have a relatively long-term investment horizon and that a short-term focus is generally not in the investor’s best interest. Yet according to a Mercer study almost two-thirds of equity fund managers exceeded their own expected turnover. In fact, the turnover was on average 26 per cent higher than claimed, with some strategies reporting turnover between 150 and 200 per cent more than expected.
The report, Investment Horizon – Do Managers Do What They Say? makes clear that investment managers themselves underestimate turnover and often do not live up to their stated claims when it comes to the holding periods for the stocks in their portfolio. The Mercer study was funded by the IRRC Institute.
“If fund managers’ actual trading behavior produces higher turnover than what they tell their clients it will be, it may signify deeper problems with investment processes. If there is deviation between the ways a strategy is managed and how it is being marketed to clients, fund managers need to be upfront and explain why. Equally, clients interested in longer-term, lower turnover strategies should feel able to ask questions of their fund manager if this is occurring,” says Helga Birgden, Mercer’s Head of Responsible Investment, Asia Pacific.
The key findings of the quantitative analysis include:
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Value managers tend to have a lower annual turnover figure than the other style types. Large capitalization portfolios have lower turnover rates than small capitalization strategies, and socially responsible investing (SRI) strategies have lower turnover than non-SRI strategies.
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Causes of short-termism include volatile markets (as has been seen during the Global Financial Crisis) and changing macroeconomic conditions; mixed signals from clients; short-term incentive systems; and behavioral biases.
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Fund managers recognize the potential destructive nature of short-termism even while claiming it was unavoidable. The managers indicated that short-termism potentially places short-term pressure on companies; increases market volatility; demonstrates a lack of discipline in fund managers’ investment processes; and creates a misalignment of interests between fund managers and their clients.
According to Jon Lukomnik, program director for the IRRC Institute, “the findings should raise serious questions for investors. When managers greatly exceed their expected turnover level, the impact can be significant in terms of cost, performance, and risk that the strategy is not being managed in line with its stated investment approach.”
