How comparable are investment manager returns?

In spite of the best efforts of the regulator, and warnings that ‘past performance is no guide to the future’, trustees continue to put recent strong performance front and centre when picking an investment manager.

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Nick Murphy
Published: 21 Nov 2019 Updated: 15 Dec 2022

In spite of the best efforts of the regulator, and warnings that ‘past performance is no guide to the future’, trustees continue to put recent strong performance front and centre when picking an investment manager. In reality, selecting the right manager for your needs is far more complex.

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To level the playing field when comparing investment manager performance, an independent consultancy called Asset Risk Consultants (ARC) persuaded almost all charity managers to submit their portfolio returns for their charity clients each month. ARC sorted the portfolios into four risk buckets based on their volatility relative to UK equities and produced an average for each firm and an average for the industry for each risk bucket, after fees. It isn’t perfect. However, it does allow performance track records from different firms to be assessed against the same criteria, the same calculation methodology and the same risk brackets.

What is apparent though is that firms are still choosing to use their own methodology to calculate their performance track records, using criteria that differ from the ARC methodology. These in-house performance track records are then compared with the ARC benchmark returns. In doing this the integrity of the comparisons is compromised.

So, at a very minimum, know how the performance track records are constructed, compare like with like and, importantly, know the sample size used to generate the “generic” track record.

However, ARC is not a panacea for all performance measurement. Trustees must all consider:

1) Focus on short termism:

A classic trap for many trustees is to buy the manager that has done well, just as the environment that suited their investment style changes. As Professor Kay* noted, ‘Focusing on recent performance, rather than detailed, and more costly, due diligence of asset managers’ investment strategies exacerbates a culture of short-termism. If asset manager selection is based on near-term performance, individual fund managers are likely to be rewarded on a similar basis, and investment decisions will deviate from investors’ long-term objectives.

The question to ask is how the manager performed through the whole investment cycle –both in rising and falling markets. Looking at five years or less of data simply isn’t long enough.

2) Don’t Judge performance in isolation:

It is important to understand the manager’s mandate, style, income objective, target return and the risk taken (measured by volatility and peak to trough drawdown), which profoundly affect performance. It is essential that the investment process is robust and shown to be repeatable.

3) Ignoring risk

A fund manager may have produced extremely good returns for investors, but they may have achieved it from a handful of concentrated short-term bets. This could bring uncomfortable volatility, or even liquidity issues. Any consideration of returns should be weighed against the risks taken to achieve those returns. A good risk guide is to look at performance periods when markets are falling.

In summary, comparison cannot be just the return number, an understanding of the underlying methodology is vital. It is also essential to ensure that trustees focus on an investment performance over a full economic cycle, both the good and the bad. Performance must not be judged in isolation and it is essential that there is a real understanding of the risks taken to drive that return.

*Kay Review, 2012

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By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.


This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.