Why Do Institutional Plan Sponsors Hire and Fire their Investment Managers?

This paper examines the investment allocation decisions of pension plans, endowments, foundations, and otherinstitutional plan sponsors. The experience and education of plan sponsors and the environment (both regulatoryand agency) of the institutional market suggests that institutional investors rely less on past performance and usediffe rent criteria when evaluating performance compared to mutual fund investors. Institutional investors areexpected to be less concerned with total returns and more considerate of benchmark-adjusted excess returns, and theconsistency with which they are delivered, over longer time horizons. An examination of asset and account flowsfor actively-managed U.S. equity products is largely consistent with these expectations. The consistency with whichmanagers deliver positive or negative active returns relative to the S&P500 over multiple horizons, without regard tothe magnitude of these returns, plays a key role in determining the flow of assets among investment products. Stylebenchmarks play a larger role in determining account movements, which is found to employ more criteria than assetmoves. However, total return is also considered, as the magnitudes of a one-year loss and 3 and 5-year total returnsare found to be incremental factors in plan sponsors? allocation decisions. One explanation for this result is theprincipal-agent arrangement faced by plan sponsors. Although the sponsors may be more sophisticated than thetypical retail investor, their clients, investors and the investment board, may not be. Plan sponsors may minimizejob risk by hiring and firing managers based on excess returns with incremental allocations based on total returns,thereby satisfying both their mandate and their clients. It is also found that smaller and older products capturerelatively greater flows.