No pain, no gain.
To avoid short-term pain, a money manager sometimes deviates from its investment strategy — even though it's the strategy that's out of favor, with no reflection on the manager's skill. The result: long-term performance suffers.
The problem is that many pension executives are unaware of the variety of strategies within a given equity style. For example, there are four distinct strategies among value equity managers, ranging from contrarian to dividend yield, according to Jeff Hansen, founder and senior consultant at Gig Harbor, Wash.-based Blue Heron Consulting Group, a consultant to money managers that spun out of Russell Investment Group four years ago.
"You don't see those strategy biases when looking at universe bar charts," Mr. Hansen said.
The bigger the spread across strategies, the more pain incurred by the out-of-favor managers, he explained.
That's why Blue Heron has introduced a "pain index" that helps explain why some managers perform worse — or better — than their respective performance universes.
For example, among value equity managers, there was a 840 basis-point spread between the best-performing and the worst-performing strategy in the first three quarters of this year, according to Blue Heron's database. Top performing midcap value strategies returned 19.9% year to date as of Sept. 30, while laggard dividend yield strategies returned only 11.5% in the same period.
Similarly, the return spread was 616 basis points for growth stock managers in the first three quarters of this year. Midcap managers again performed best, at 22.8%, while consistent growth managers returned 16.7%.
"The best course of action for most managers is to stay with their current strategies during the periods of poor performance," Mr. Hansen said in a press release. "Unfortunately, high short-term pain causes managers (and their clients) to deviate from their strategies. In their attempts to chase the performance of a better performing strategy, they get whipsawed and their clients lose."