In three previous posts (here are the first one, second one, and third one) we have been building the case that the rise of a class of "financial advisors" who do not manage money themselves (they do not actually make the buy-and-sell decisions on individual stocks and individual bonds) but rather "pick managers" (selecting mutual funds or portfolios that are managed by someone else) may well have led to lower long-term returns for their clients.
We have suggested that the reason for this may be that these manager-pickers "churn" managers, not out of an underhanded desire to make commissions (the financial advisors are usually paid an annual fee rather than commissions, although many can receive commissions as well) but rather out of a desire to be doing something to earn their fee, as well as out of a desire to replace under-performing managers with better-performing ones.
We believe that the data in several years of the Dalbar Quantitative Analysis of Investor Behavior support this conclusion.
Now a Boston University professor of finance has published a study which indicates that institutional investors may be doing the same thing! A recent article in Advisor Perspectives entitled "Maybe Smart Money . . . Isn't So Smart" describes the research done by Scott Stewart, a former institutional fund manager and now finance professor, using data from Effron PSN.
As the graph above demonstrates, in the words of the article, "Stewart's data show convincingly that plan sponsors destroy value when shifting assets." They typically shift money into managers whose portfolios have recently outperformed, resulting in significant under-performance going forward.
Stewart himself states that: "the effort that plan sponsors are putting towards hiring and firing managers is not just a waste of time. It is actually hurting them."
In other words, data shows that the institutional investment community, which is dominated by institutional "investment management consultants" who (like the "financial advisors" dominating the retail investment world) are not money managers themselves but rather help institutional investors "pick managers" and shift from one manager to the next, is being harmed by the same phenomenon we have been discussing. The data seem to suggest that the intermediary between the investor and the money manager is not adding value but may well be destroying value.
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