The Trouble with Manager Picking

We examine the selection and termination of investment management firms by plan sponsors (public and corporate pension plans, unions, foundations, and endowments). We build a unique dataset that comprises hiring and firing decisions by approximately 3,700 plan sponsors over a 10-year period from 1994 to 2003. Our data represent the allocation of over $737 billion in mandates to hired investment managers and the withdrawal of $117 billion from fired investment managers. Plan sponsors hire investment managers after large positive excess returns up to three years prior to hiring. However, this return chasing behavior does not deliver positive excess returns thereafter; post-hiring excess returns are indistinguishable from zero. Plan sponsors terminate investment managers after underperformance, but the excess returns of these managers after being fired are frequently positive. Using a matched sample of firing and hiring decisions, we find that if plan sponsors had stayed with fired investment managers, their excess returns would be larger than those actually delivered by newly hired managers.