Tuesday, March 19, 2013

Retirement Plan Advisor - Reason #5

5. Investment Manager Replacement

The Plan Advisor’s due diligence on investment managers may reveal a manager that no longer meets the selection criteria in the IPS. The Plan Advisor should notify the institution on a timely basis and the specific criteria under which the manager is deficient. Depending on the number of selection criteria deficiencies and severity of the problem, the Plan Advisor will recommend that the manager be placed “under review” or be immediately replaced.

When a manager is placed under review or on a watch list, the Plan Advisor heightens due diligence, focusing on the criteria where performance fails to meet minimum standards. For example, the IPS selection criteria may state that a large cap growth manager’s performance must consistently meet or exceed the annualized trailing three-year and five-year returns of the Russell 1000 Growth Index. When a large-cap growth manager fails to meet these criteria, the Plan Advisor will perform attribution analysis in an effort to understand the reasons for the underperformance.

Attribution analysis can be done at both the sector and individual security levels, to determine the nature of the manager’s underperformance. When a manager is placed under review, there should be a clear understanding among the fiduciaries and the Plan Advisor that this is only a temporary status. The best practice would be for the Plan Advisor to do all the necessary research on a manager under review as soon as possible. Then the Plan Advisor presents this information to the institution with a recommendation to either remove the manager from “under review” status or commence a manager-replacement search.

Situations sometimes arise where the need to replace a manager is obvious. A common reason for manager replacement is a significant shift in investment style. Also known as “style drift,” this can undermine the institution’s asset-allocation strategy. For instance, when a small-cap manager “drifts” into the mid-cap segment of the market, it creates both a gap and a potential redundancy in the portfolio’s asset allocation. The process to replace a manager is similar to the original search and selection process, except that the performance analysis compares the incumbent manager with the replacement candidates and the benchmark index. Manager replacement can be challenging for the fiduciaries, even with a well-written IPS as a guide. It is an important decision, and as with all fiduciary actions, the process should be fully described and documented in the institution’s records.


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