Institutional managers—who typically manage large sums of money for things like pensions and university endowments—may be trading more frequently than their clients think. A study released Tuesday by the Investment Responsibility Research Center Institute reports that institutional investment managers trade more often than they say they do, based on data collected by investment consultant firm Mercer. For the study, the IRRC Institute teamed up with Mercer to analyze about 800 investment strategies (including large-cap value, small-cap growth, and socially responsible investing) that institutional managers use to invest in the U.S. stock market and throughout the world. From June 2006 through June 2009, the study showed that about two thirds of institutional investing strategies had a higher-than-expected average turnover. The actual turnover—a measure of how often managers change holdings—among the different strategies was, on average, 26 percent higher than anticipated, and some strategies showed turnover between 150 and 200 percent more than expected, based on Mercer's data.
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The IRRC Institute focuses on corporate responsibility and investor education and has conducted other studies on issues such as corporate governance and the transparency of sovereign wealth funds. Jon Lukomnik, program director for the IRRC Institute, says the study aims to determine "whether investment managers—who are primarily dealing with long-term investors because these are institutional managers who are dealing with pensions and endowments—do what they say they're doing," he says.
The study doesn't assess how the turnover affected the managers' performance. It focuses solely on whether managers trade more frequently than they said they would in interviews with Mercer. Higher turnover generally means higher costs and more volatility, and turnover is something that investors should make note of in their portfolios. Lukomnik says the study shows that many institutional clients may be supporting the type of short-term trading mind-set that they are opposed to. "It's not hedge funds and day traders alone but the mainstream investment managers—the part of the market that you think is most long-term—that trades shorter term than they tell their clients they're going to trade," he says.
The institute examined what the expected turnover rate was for these strategies, then compared it with the actual turnover rate. The study found that a large majority of the managers said that trading at a more frequent pace was "unavoidable." After analyzing the investment strategies, Mercer conducted interviews with eight fund managers and asked them to explain why they traded the way they did. The managers were given a chance to explain their turnover anonymously. The causes for more frequent turnover included "volatile markets and changing macroeconomic conditions," "mixed signals from clients," and "short-term incentive systems." The managers also said they realized that a higher-than-expected turnover strategy "creates a misalignment of interests between fund mangers and their clients." When managers were asked if they believed there were any solutions to the problem, they responded with answers like more regulation in the industry and better client understanding so that managers felt they wouldn't be fired for short-term periods of underperformance.