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© Copyright 2000 Rogers Media. The following article first appeared in the March 2000 edition of
BENEFITS CANADA magazine.
Better judgment
Manager evaluation is rarely a straightforward process. Especially when you focus too sharply on
the short term.
BY BARBARA CLAPHAM
Now that we are well into the new year, many pension fund fiduciaries are reviewing the performance of
their managers for 1999. Unfortunately, many will use flawed methodologies to do so. In the spring issue of
Canadian Investment Review, Bruce Curwood, a senior consultant at Frank Russell Company in Toronto,
writes how fiduciaries, well-intentioned though they may be, often fall prey to common pitfalls when
evaluating performance.
The process frequently begins by examining hard return data, comparing the portfolio return as of Dec. 31
to a benchmark such as the Toronto Stock Exchange (TSE) 300 composite index. Such a comparison is likely
invalid.
Most managers underperformed the TSE 300 in 1999, one reason being that the shares of Nortel Networks Inc.
rose almost 400%, making up a large part of the TSE's 31.7% return. Nortel comprised the index weighting in
few pension and endowment fund portfolios. Any relative performance comparison should take into account
unique characteristics of the plan such as manager style, sponsor's risk tolerance or chosen asset mix.
Often fiduciaries assess the manager's performance over too short a time period of four years or less. The
four-year period, according to Curwood, probably stems from the U.S. presidential cycle, which was presumed
to coincide with the business cycle and capital market returns. However, the average business cycle in
Canada is much longer than four years. The last two have lasted over eight years.
Measuring over short periods picks up too much white noise.
THE RIGHT INFORMATION
Why do fiduciaries fall prey to such errors? Several reasons. One, they tend to be time pressed, having
busy, full-time jobs to attend to. Secondly, many come from business, and therefore naturally think in
business terms. Used to looking for results on a quarterly basis, several years may seem an eternity to
wait for positive results. Finally, many simply lack the necessary education to be an effective fiduciary.
Can fiduciaries overcome these pitfalls?
Curwood says yes--if they are given the right information. Many plan sponsors only provide their
fiduciaries with core performance data, such as return numbers and comparative analysis. If the results
appear unfavourable, and no other offsetting information is provided, unnecessary manager turnover may
result.
Analyzing the past is easy. What fiduciaries need to know is whether positive results can be expected in
the future. Two other types of information add balance to the process: portfolio profile analysis and
manager research.
Curwood stresses how examples of actual strategies and results should be used to help fiduciaries better
understand the choices they are being asked to make. If a decision is made to try and outperform an index,
for example, the risk of underperformance must be accepted. Once the game plan is established, portfolio
profile analysis ensures the managers stick to their stated investment styles.
When selecting a manager, historic return performance should be analyzed to determine if the fiduciaries
can tolerate the potential volatility of returns. This helps fiduciaries fully understand the concept of
risk and the possible fluctuations in returns which can be expected. After hiring, they should meet and
talk regularly with the manager, instead of relying on a short annual presentation.
Implementing this three part process, Curwood says, and clearly explaining it to fiduciaries, will ensure
appropriate methods are used to assess manager performance.
Barbara Clapham is a contributing editor to BENEFITS CANADA.
*** ***
Conferences
New Developments in Pension Fund Governance
Mar. 6-7, 2000, Toronto
This conference, sponsored by the Institute for International Research, will cover governance best
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Call (800) 941-9403 or visit www.iir-canada.com.
Successfully Transitioning from a Defined Benefit to a Defined Contribution Pension Plan
March 29, 2000
Toronto
Topics at this day-long event include designing the new DC arrangement, communications and plan governance.
Call (800) 941-9403.
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