Many investment decisions are made using historic data, so that fund managers are backed based upon strong past performances rather than potential future performances. Research from the Samuel Curtis Johnson Graduate School of Management suggests this is a major problem.

The researcher believes that investors can improve their selection process by collecting data on the performance of terminated fund managers as well as those that have been retained. This would give them a fuller understanding of performance. They conducted previous research back in 2009 that found that poor fund manager selection resulted in a loss of about $170 billion.

“In that research project, we wanted to look at two issues,” the researcher explains. “One was, why do institutional money managers—people who run foundations, endowments and pension plans—move money from one manager to another? And two, does this add value?”

Investment mistakes

The author suggests that a mistake many managers fall into is that they fail to factor in the performance of money managers that have been fired into their investment decisions.

The theory was tested using three surveys of investors regarding the investment decisions they make for pension plans. The results from all three surveys show that investors were highly confident in the selections they made, but the author believes this confidence is misplaced.

“The first is way that information is reported,” he explains. “When an endowment, for example, reviews the performance of their managers, they only look at the performance of their current management system. So if a manager goes through a bad period, and you fire them soon after, they’re not on the list in the next quarterly report. The bad information disappears, but there also is good information in that manager’ subsequent record.

There is also a psychological aspect to how people tend to make decisions, and especially in terms of the information they look for to reinforce those decisions. Often in life we don’t know how decisions we didn’t take would have turned out, but this isn’t the case in investing as the possible returns are visible.

The best approach, therefore, is to ensure that you try and get that kind of information. For instance, the author advocates benchmarking new managers against the performance of those managers that were terminated. Indeed, hiring managers with poor performances in the past may even be profitable due to the fluctuating nature of the markets.

“Pause and think before firing a ‘bad’ manager,” he concludes. “You may be doing it just at the wrong time.”