Over the past two decades, plan sponsors have focused on past performance data when selecting investment managers. A high ranking in the investment management universe dramatically increases the likelihood that an investment firm will be selected by institutional investors. Yet the evidence does not support the hypothesis that strong past performance is predictive of future success.
Cognitive errors promote continued reliance on past performance data. For example, sponsors tend to confuse a firm’s business success with the true skill of its managers. Many see strong past performance and prestigious client lists as representative of future investment management ability. Other cognitive biases and incentives inherent in plan sponsor decision-making structures reinforce a dependence on past performance data.
A renewed focus on investment objectives can help plan sponsors better control the manager selection process. In particular, manager selection decisions should be viewed in the context of the plan’s overall strategic planning. Appropriate incentive systems and evaluation procedures can improve the performance of institutional investment programs.