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By Christine Benz | 09-27-2010 05:53 PM

What's Important When Hiring or Firing a Fund Manager?

Vanguard's Catherine Gordon presents her research that the stability of an investment team and low-costs should be the most important factors when selecting a fund manager.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. What factors should you take into account when deciding whether to hire or fire a fund manager? Here to discuss that question is Catherine Gordon. She is Head of Institutional Advisory Services for Vanguard. Catharine, thanks for joining me here today.

Catherine Gordon: Glad to be here, Christine.

Benz: So you recently conducted some fascinating research into this question of how investment committees decide whether to hire a fund manager or give him or her the heave-ho. And I wanted to talk about first what you found and also then talk about what the implications might be for individual investors from that research. So, first, let's talk about the thought process that you see investment committees engaging in when deciding whether to hire or fire?

Gordon: Sure. We were very interested in that whole process, obviously as an investment management firm, how committees go about doing that and so we surveyed a number of committee members, got over 100 responses and some of which corroborated what we thought would be the answers and got a few surprising answers.

I think some of the things that we found in the research is performance plays a large role in whether or not to hire or fire an investment manager. But committees also looked at a number of other factors in that decision, placed heavy emphasis on style, consistency, fees played a large role.

On average the committees changed generally one manager a year and the one thing that kind of surprised us was that they found that it was harder to hire a manager than it was to fire a manager and we would have thought it would have been harder, given relationships, it would have been harder to fire a manager with whom they have had a relationship over a number of years, but it was actually quite the opposite. We also found that committees have a high degree – we felt they had a high degree of investment knowledge, so over 90% indicated that their investment knowledge was above average.

Benz: So I want to drill into a couple of these points. So, first of all, these are committees who are making decisions on behalf of foundations or institutions or some other entity. So in terms of this, easier to fire than hire, you are right, to me that seems really counterintuitive. What do you think is driving that tendency?

Gordon: I think it's partially because it takes a lot of work upfront. Typically these committees are evaluating a number of potential managers, it takes time. So I think probably time – the fact that it's harder is probably it takes more time on their part to evaluate the prospective manger. But as I said, that was one of the aspects of the survey that did surprise us.

Benz: And the overconfidence that's something that has come up in the academic literature about investor behavior and general human behavior that we see people tend to overestimate their own ability. Is that something you found here with these committees as well?

Gordon: Actually in another dimension of the survey 63% of the responses indicated that they seldom made mistakes.

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