Institutional investment management is an industry where performance is everything. Portfolio managers and their teams face intense pressure to deliver favorable results for their clients or risk losing their business altogether. However, consistently generating strong performance over the long-term is extremely difficult.
Studies reveal that nearly 70 to 80 percent of investment managers underperform benchmark averages over 3 to 5 year periods. This means that most teams will inevitably encounter periods of painful underperformance sooner or later.
“If not managed correctly, these periods can extend beyond clients’ or employers’ tolerance and lead to client departures, asset losses, shutdowns or team leadership turnover,” says Juan C. Espinoza, an investment management expert. This is why it’s critical for teams to confront extended periods of underperformance head-on and swiftly implement strategies to turn things around.
Why Do Investment Teams Underperform?
There are a variety of reasons why even the most seasoned investment teams can hit rough patches and endure prolonged stretches of disappointing returns compared to benchmarks or competitors. According to Espinoza, some of the most common causes include:
Strategy Issues
One major factor is problems with the investment strategy itself. For instance, the team may be executing the strategy incorrectly, like overpaying for valuations in a value-focused fund. Or the strategy could have inherent design flaws that only emerge after a period of implementation.
“One example is a fund that only produces favorable results during low interest rate environments and lacks flexibility to adapt to higher rates. A fund like this could be doomed from the start,” Espinoza explains. “Issues of strategy need to be corrected immediately. When that’s not possible, managers must return funds to investors quickly or risk their careers and reputations.”
Lack of Skills
Though difficult to acknowledge, poor performance sometimes reflects a simple mismatch between the technical complexity of the task and the skill level of the team. Weak links could exist at the senior portfolio manager level or among the supporting analysts. Contributing issues range from deficient hiring practices and premature promotions, to inadequate mentoring programs and low productivity standards.
“Lack of talent can take a while to resolve, and the problem may outlive clients’ patience, which is why institutions are better off diagnosing and addressing these limitations proactively,” says Espinoza.
Resource Constraints
Outperforming benchmarks and meeting client expectations over the long haul is an immense challenge. It demands extensive preparation, talent, a competitive drive, and robust infrastructure. In investment management, infrastructure encompasses back-office resources, compliance, IT systems, client support, and, importantly, resources for actionable investment research.
“Shortchanging a team on resources will eventually show in weaker investment results,” Espinoza notes. “Institutions not committed to properly supporting their teams will fall behind as clients suffer from extended periods of poor returns and look to exit.”
Dysfunctional Team Dynamics
One of the toughest factors to diagnose and resolve is weak or dysfunctional team dynamics. Ineffective communication, lack of collaboration, and internal conflicts can lead to suboptimal decisions, excessive friction, and persistent distrust within a team.
“One of the least discussed issues in this industry is that portfolio managers often get promoted based on investment returns, not leadership skills,” says Espinoza. “Teams that lack cohesion, strategic direction, or transparent communication inevitably see their dysfunction reflected in poor performance, low morale, team turnover and burnout.”
Turning Underperformance Around
Investment management attracts ambitious, competitive individuals to firms that are generally well-run and focused on excellence. But markets are uncertain, and even the most seasoned professionals are fallible. Prolonged underperformance requires a multifaceted response that examines both portfolio data and team dynamics to understand and resolve the root causes.
Clarify the Strategy
Take time to re-evaluate the investment strategy and ensure the team has a well-defined philosophy, clear goals, robust processes, and the skills to execute on that strategy successfully. Identify any flaws in the strategy itself and correct them immediately, or consider returning funds to clients if the issues cannot be resolved.
Check for Skills Alignment
Honestly assess the abilities of both senior leadership and supporting team members to ensure the team has the talent and competencies to implement the strategy effectively. Identify skill gaps and invest in coaching, mentoring, training, and hiring to bridge them.
Assess Resource Needs
Review infrastructure, research budgets, compliance support, and other resources to confirm they are adequate for the strategy and objectives. Upgrade capabilities where required to provide the investment team with competitive advantages that can translate into outperformance. A firm must be willing to invest in these resources ahead of its own payback. Not doing so reflects poorly on their willingness to serve clients and reveals a short term mindset that could eventually hinder investment results.
Improve Team Dynamics
Evaluate team communication, collaboration, and engagement. Resolve underlying issues through team building, conflict resolution, leadership development, and clarifying roles and responsibilities. Assist the team with qualified HR or behavioral professionals if needed. Team dynamic issues tend to fester and worsen if not resolved head-on
Adopt Risk Management Best Practices
Ensure rigorous risk management processes are in place. Exposure limits, stress testing, and stop-losses are among the most obvious. Review and enhance risk management capabilities as markets evolve. Behavioral finance has been around long enough that there is no excuse to fall into well-researched psychological biases that cost clients’ money.
Encourage Adaptability
Build a culture of constant learning and willingness to evolve. Regularly review the investment strategy and adjust its components to adapt to changing market and industry conditions. Investment management attracts extraordinary talent and yet, they’re still only human. Overestimating one’s ability is a common human flaw. Unfortunately, in this business undue confidence can result in costly consequences for clients.
According to Juan, “A team’s underperformance needs to be analyzed and understood before it can be addressed. Looking at the problem holistically to assess people and processes accordingly can result in better solutions that protect clients’ capital and build the organization whether the causes are technical or behavioral in nature.”
To learn more about Juan C. Espinoza and his approach, check out his LinkedIn profile.
