This article appears courtesy of Institutional Investor
Source: Money Management Letter
The most common mistake pension funds make is evaluating managers based on their short-term performance, giving too much praise to managers having a good run and over-criticizing firms experiencing short-term underperformance, according to Michael Oyster, consultant at Fund Evaluation Group. Oyster, who authored a paper on avoiding the pitfalls of investing for FEG's February Research Roundup, said three years is too short a time period in which to assess managers. FEG conducted a study which showed that all the U.S. large-cap managers that posted top quartile returns for the 10 years ending December 2005 ranked below the median for at least one rolling three-year period during that time.
"Performance can sometimes have a lot less to do with skill than luck," said Oyster. For instance, growth manager Janus Capital Group shot the lights out in the late 1990s, but when growth fell out of favor at the start of this decade, Janus underperformed and started losing money. "Did they suddenly become unskilled? No, their style went out of favor."
Another conundrum for institutions is how to invest a large infusion of cash. In a down market, investors are inclined to hold onto cash until the market stabilizes, but they could miss out when the market rallies. If the market is climbing, however, and an investor holds off until it looks cheaper, the investor could miss out. "Investing with the long-term strategy you have in place is really the only option," Oyster told MML.
A key pitfall in hedge fund investing is paying high fees for beta. But hedge fund investors should not solely seek the best fee arrangements, because upstart managers anxious to gather assets are more willing to be competitive on fees than the better, more established managers. A danger with private equity is becoming seduced by hot strategies. A private equity manager that's an expert in a certain field can tell a good story, Oyster said, but pension funds need to diversify by manager, vintage year and strategy. Oyster has written a book on investing, Mission Possible: Achieving Outperformance in a Low-Return World.