Some active equity fund managers have higher portfolio turnover rates than they themselves claim, a new study finds.
Nearly two-thirds of institutional investor-focused investment strategies exceeded their expected turnover from June 2006 through June 2009. Of these strategies, the turnover was on average 26% higher than anticipated, with some strategies reporting turnover between 150 and 200% more than expected
The report from Mercer demonstrates that investment managers themselves underestimate turnover and often do not live up to their stated claims when it comes to the holding periods for the stocks in their portfolio. The study, funded by the not-for-profit IRRC Institute examines the investment horizon of active equity investment managers, comparing various strategies, different geographies and styles.
"Short-term investing is often cited as an issue by the press, policymakers, academics, and many in the business and investing community," noted Jon Lukomnik, Program Director for the IRRC Institute.
"What has not been recognised until now is that this is not only particular to day traders or arbitrage funds or others who may have short time horizons by design. When two-thirds of long only equity institutional investment products have turnover that exceeds what they themselves expect, there is a systemic issue."
He said the findings should raise serious questions for investors. "When managers greatly exceed their expected turnover level, the impact can be significant in terms of cost, performance, and risk that the strategy is not being managed in line with its stated investment approach."
"A deviation in actual versus expected turnover can be a possible indicator of deeper problems with investment processes," said Danyelle Guyatt, the Head of Research for Mercer's Responsible Investment team and the report co-author. "Clients interested in a strategy that seeks to capitalise on longer-term trends and hold stock in corporations for longer periods need to be aware if that situation is changing and why," she added.
The study took two approaches to the data analysis. First a quantitative analysis of portfolio turnover of over 900 strategies examined intended and realised average holding periods for various investment products across different regions and styles. Then Mercer researchers conducted a qualitative case study analysis on eight active equity fund managers.
The key findings of the quantitative analysis include:
Nearly two-thirds of strategies have turnover higher than expected, with some strategies recording more than 150-200% higher turnover than anticipated. Of the 822 strategies for which Mercer had expected and actual turnover information, 550 exceeded the turnover during the sample period. The average turnover was 26% higher than anticipated.
Within the entire sample of 991 strategies, the average annual turnover of the sample is 72%, with some 20% of strategies having turnover of more than 100%.
Value managers tend to have a lower annual turnover figure than the other style types. Large capitalisation portfolios have lower turnover rates than small capitalisation strategies, and socially responsible investing (SRI) strategies have lower turnover than non-SRI strategies.
Across regions, UK, Canadian and Australian equity strategies have the lowest average turnover value, while European (including UK), international and US strategies have the highest average turnover levels.
The key insights from the qualitative case study analysis from the fund managers find that the causes of short-termism include volatile markets and changing macroeconomic conditions; mixed signals from clients; short-term incentive systems; and behavioural biases;
Fund managers recognise the potential destructive nature of short-termism even while claiming it was unavoidable. It potentially places short-term pressure on companies; increases market volatility; demonstrates a lack of discipline in fund managers' investment processes; and creates a misalignment of interests between fund managers and their clients.
The complete study, Investment horizons - do managers do what they say? is available free at www.mercer.com/ri.
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