Swedroe: Don’t Buy Winners

February 19, 2016

Hiring And Firing

Amit Goyal and Sunil Wahal, authors of a May 2005 study, “The Selection and Termination of Investment Management Firms by Plan Sponsors,” evaluated the selection and termination of investment management firms by plan sponsors (public pension plans, corporate pension plans, union pension plans, foundations and endowments).

They built a dataset with the hiring and firing choices from approximately 3,700 plan sponsors from 1994 to 2003. The data represented the allocation of more than $737 billion in mandates to hired investment managers and the withdrawal of about $117 billion from fired investment managers. The following is a summary of their findings:

  • Plan sponsors hire investment managers after large positive excess returns up to three years prior to hiring.
  • Return-chasing behavior does not deliver positive excess returns thereafter, with post-hiring excess returns indistinguishable from zero.
  • Plan sponsors terminate investment managers after underperformance, but the excess returns of these managers after being fired are frequently positive.
  • If plan sponsors had stayed with the fired investment managers, their returns would have been larger than those actually delivered by the newly hired managers.

It is important to note that the above results did not include any of the trading costs that would have accompanied transitioning a portfolio from one manager’s holdings to the holdings preferred by the new manager. The bottom line: All of the activity was counterproductive.


Cornell, Hsu and Nanigian drew two main conclusions: “First, a heuristic of hiring recent outperforming managers and firing recent underperforming managers turns out to be 180 degrees wrong …. Second, consistent with previous research, it appears superior investment performance is more a function of the systematic exposures (a persistent investment style) that managers embed into the portfolio, not some nebulous talent—elusive and unique alpha skill.”

Their findings clearly present a tremendous challenge and problem to investors who base decisions on past performance. The practical implication is that investors should clearly focus on factors other than past performance when selecting fund managers.

Thus, the logical conclusion should be that the strategy most likely to allow you to achieve the best results is to focus instead on the selection of passively managed funds that provide you with the desired amount of exposure to the well-documented factors that explain the differences in returns of diversified portfolios—factors such as beta, size, value, momentum and profitability/quality for equities and term and default for bonds—and do so in a low-cost and, for taxable investors, tax-efficient manner.

Unfortunately, the belief in active management as the winning strategy is so deeply embedded for so many investors that, faced with such evidence, the likely outcome is that they will experience cognitive dissonance. As a result, the evidence is likely to be ignored because facing up to it would be too painful an admission of belief in a false theory.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.

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