News & Insights

Should you change managers if your investment portfolio is falling in value?

22 August 2022, Gemma Howe

Investing is appropriately viewed as a long-term activity, but markets are short-term animals. The current regime change is a perfect example; after many decades of bonds and equities working well in tandem to distribute risk, bonds and equities are both down for the first time in many investment professionals’ careers. 

Investment portfolios that were once considered low-risk are suddenly looking less so. A traditional 60/40 split portfolio may no longer suffice in this brave new world of soaring inflation and geopolitical upheaval.

Given the current backdrop, it’s only natural for investors to wonder about their next move.

Investors tend to consider changing their investment manager in the face of capital loss—but this is an inherently risky move. Terminating an investment manager is a major change, potentially disrupting the ebb and flow cycle that enables your portfolio to weather storms over the long term.

Put differently: changing managers at the wrong time can turn temporary poor performance into permanent damage.

In this article, we’ll consider the human element in investing, and what—if any—action investors should take to adjust their relationships.

How important are managers in investment performance?

In his book Thinking, Fast and Slow, psychologist Daniel Kahneman discusses the hindsight bias—the illusion that past events were as predictable at the time they happened as they are now. This bias convinces us that the world is more predictable than it actually is, and gives us an undue amount of faith in our ability to forecast future events.

Biases like these encourage us to find faults where none exist, so it’s important to keep them in mind when considering an investment manager’s overall performance—particularly when you consider the high risk of making a change.

We looked at market data over a 25-year period to determine the cost of missing just five of the top-performing days within that period. The numbers are staggering; a buy-and-hold investor who starts with $100,000 and stays in the market during periods of volatility accumulates $216,000 dollars more than one who makes a poor timing decision and misses just the top 5 days. Damage to returns is even more significant when additional high-performing days are missed. Our buy-and-hold investor earns a 7.3% annualised return, where a trader who misses the 10 best days in the market earns only 4.1% p.a.

US Market Missing Days
Source: SPDR S&P 500 ETF and Lipper for Investment Management, LSEG

Changing managers due to underperforming funds can easily lead investors to a similarly poor timing decision, as the best days in financial markets tend to follow closely behind challenging periods.

Investment managers are important - but not always in the way you think

Of course, not all investment managers are created equal. Skill and performance do matter. But investors tend to look at the wrong metrics when assessing their manager’s performance.

The key is to ask the right question. Not “Why is my performance so bad?,” but “Are we still doing the right thing?”

No one can predict the future in a meaningful way with a high degree of accuracy or persistence. Two of the greatest economists of the early 20th century, Irving Fisher and John Maynard Keynes, both failed to anticipate the stock market crash of 1929. Both lost fortunes by failing to forecast accurately.

While you can’t predict the future or guarantee a specific return, you can control your level of risk. Very often, investors enter the market with the correct risk profile only to change their approach when the market takes a dip. They’re forced to sell assets in a distressed market, often at the wrong time, effectively spending money rather than earning it.

If the level of trust between you and your manager is good, a change is seldom the best course of action. Try not to constantly analyse what the market is doing, and look instead at your goals and your overall strategy. With a suitably calibrated risk profile, staying the course through volatile periods is almost always the best approach.

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The best managers take the time to thoroughly understand your objectives so they can orient your investments accordingly. Does the behaviour of the investments match your original expectations? A quick way to check is by comparing the expected maximum loss to what has actually happened.

How to understand investment manager performance

That said, it’s still important to assess your investment manager’s performance. Here is our advice for evaluating your investment manager’s performance relative to your goals:

Confirm their understanding of your objectives. The best managers take the time to thoroughly understand your objectives so they can orient your investments accordingly. Does the behaviour of the investments match your original expectations? A quick way to check is by comparing the expected maximum loss to what has actually happened.  This should be provided by your manager.

  • Measure performance against industry benchmarks. Market indices like the S&P 500 or FTSE 100 can help provide a frame of reference but generally aren’t useful as a direct measurement tool.  Almost all investment managers will have a market-based benchmark specific to your portfolio. (Watch out for historical changes to the composition, though.)
  • Conduct peer-to-peer comparison. The best way to determine your manager’s performance is to consider what you could have achieved elsewhere. Our own ARC Indices are the only risk-adjusted benchmark that accounts for all investment types. Use these benchmarks as an indication of your manager’s performance. What have other managers produced for a comparable level of risk

Should you stay or go?

Even if your manager has failed to keep pace with market return indexes, you’d need to find another manager who will perform better in the future to make a wise change. Ensure that any new managers you evaluate have cleared the same hurdles you’re using to hold your current manager accountable.

Here is a shortlist of qualities to look for, either in your current fund manager or in a prospective one:

  • Consistency: Look beyond pure historical performance to the nature of the outcomes. Can a manager consistently meet their clients’ real return targets? ARC’s consultants provide investors with a look behind the curtain to help you identify managers who have consistently performed well over a long period.
  • Transparency: Ask your fund manager to share their real return comparator. Most will produce one if asked. This figure is a valuable tool to use when assessing manager competency because it allows you to see returns in a real-life context—i.e., have you maintained your purchasing power in the face of inflation?
  • Understanding: Last, but certainly not least, communicate your financial goals to your manager and make sure they’ve designed a strategy to help you reach them. If you can’t liquidate your assets as and when you need them, your investment strategy has gone awry.

Changing managers can be so expensive that it negates the gains of a change. Anecdotally, we estimate the cost of change to be 3-4%, a hit from which it can take years to recover.

If you do decide to change managers, be cautious about your timing. You don’t want to terminate your relationship and liquidate your assets just in time to miss a few good days on the market. As our research on missed market days demonstrates, your portfolio would struggle to catch up.

Consistency is one valuable predictor of future investment manager performance, but there are others. ARC has been measuring investment manager performance carefully since 1995, so we have over a quarter century of data to spot valuable patterns in manager behaviour.

It’s one thing to know that you did better than average—but it’s far more interesting to know how much better. Compare your investment manager performance using the ARC Indices, an unbiased and no-cost source of peer group performance data across five currencies and the most popular risk profiles.

Our clients reach their goals with us by their side. Why wait?