Abstract
Performance monitoring and accountability is an absolutely critical step in ensuring a successful transition, no matter who you hire to manage the event.
In 1924, a series of experiments began at the Western Electric factory outside of Chicago to study the effects of lighting. The intent of the experiments was to determine whether worker productivity improved with increases in illumination in the factory. Initial studies did seem to indicate that productivity at the plant improved as lighting levels increased.
However, when researchers decided to repeat the experiments with lower light levels, they were surprised to find that productivity levels also increased. When other variables were studied over the ensuing years, productivity usually increased, even when the variable change was a return to original work conditions. When experiments stopped, however, productivity fell back to its original levels.
Researchers concluded that the level of productivity often was increasing not because of changes in work conditions, but rather because the workers knew they were being monitored during the experiments. This phenomenon—that people will perform better when they are being studied—is called the Hawthorne Effect after the name of the factory where the initial studies were conducted.
More recent research has expanded our understanding of the Hawthorne Effect. One study completed in 1985 found that monitored tasks elicited better performance because subjects viewed their work as being more important and expected to have to defend their efforts.1
Likewise, performance monitoring not only establishes that the work is critical, but it also provides additional pressure to perform well. A study by James Larson and Christine Callahan in 1990 found that people respond with better performance when being monitored, even when no consequences result.2
PERFORMANCE MONITORING
This effect of performance monitoring has important ramifications for transition management. One of the key benefits of hiring a transition manager is to monitor portfolio performance and establish accountability during a restructuring. This aligns the interests of the transition manager with those of the client, which—in accordance with the principles just established—can lead to better results.
Yet this step is often skipped when plan sponsors allow investment managers to liquidate or build portfolios instead of hiring dedicated transition managers. Rather than monitoring the performance of incoming investment managers and holding them accountable, plan sponsors often allow managers to trade into the new portfolio without any performance monitoring in place or consequences if costs are high.
This “performance holiday” lasts for some temporary period of time, until the new manager has finished the transition to the desired portfolio holdings. Only when their new portfolio has been constructed does performance measurement begin. The purpose of this delay is to eliminate the chance that initial trading costs and market volatility will put the newly hired manager behind the benchmark. According to the Hawthorne Effect, such a delay in performance monitoring may have adverse consequences.
CONTROL YOUR DESTINY
Despite the benefits of transition management, some plan sponsors decide not to hire transition managers when changing investment managers. In so doing, they are effectively appointing the outgoing or incoming manager as the transition manager. But you can make such a decision and still retain some of the benefits of transition management. Consider the following.
Do Your Research
Not all investment managers are equally skilled at trading. Some managers invest heavily in trading personnel and technology, while others do not. Even a brief investigation of execution capabilities will differentiate between an investment manager with sophisticated traders and one for whom trading is an afterthought.
Talk to your investment manager about trading expertise and proposed transition strategies. Look for warning signs, such as managers that
• outsource trading to brokers rather than trading in-house;
• use volume-weighted average price (VWAP) as a benchmark;
• focus on buying new securities instead of coordinating sells and buys;
• plan on utilizing limit orders for their buys; or
• do not have a strategy for staying market neutral.
Start Performance Monitoring Immediately
Performance should be monitored as soon as the new investment manager’s account is funded with securities and cash. Consistent with psychological studies, monitoring for performance sends a message that the transition to the new portfolio is important. You are also providing a strong incentive to manage the restructuring well. In short, without performance monitoring and accountability, you will not have full alignment of interests.
Review Commission Rates
Transitioning to a new investment manager typically results in turnover in the portfolio and, consequently, commission expense. Commissions are invaluable to investment managers, who use them to receive better brokerage coverage and access to research. Before trading begins, talk to your investment manager about the commission levels they expect to pay and whether commission dollars will be used to pay for research. You will quickly discover whether your manager is paying high commissions and whether they are generating soft dollars or research credits from these trades.
Ask for Post-Trade Reporting
Regardless of what path you take, the initial funding of a portfolio can be an expensive undertaking. It is not unheard of for transition costs to exceed 100 basis points. Therefore, you should ask for and expect to receive a report from the new investment manager on the costs associated with building the initial portfolio. Because you will be monitoring performance throughout, this post-trade report will help you attribute the portion of the first quarter’s and year’s performance to the initial transition.
CONCLUSION
When changing investment managers, you will need someone to manage the transition to the new portfolio. The question is not whether to hire a transition manager, but instead whether to hire a specialist or to leave implementation up to the newly hired manager. When no transition manager is hired, the incoming manager becomes the de-facto transition manager, handling the building of the new portfolio, making strategic choices and deciding how to implement your investment decisions. Do not give them free rein. Put them on the performance clock, minimize commission rates, and ask for cost reports. If nothing else, managers will know you are monitoring them—and you will be leveraging the Hawthorne Effect to your advantage.
ENDNOTES
↵ 1Ferris, G., D. Fedor, K. Rowland, and J.F. Porac. “Social Influence and Sex Effects on Task Perceptions and Performance.” Journal of Vocational Behavior, 26 (1985), pp. 66-78.
↵ 2Larson, J., and C. Callahan. “Performance Monitoring: How It Affects Work Productivity.” Journal of Applied Psychology, 75 (1990), pp. 530-538.
- © 2011 Pageant Media Ltd
In this issue
Jump to section
Similar Articles
Cited By...
- No citing articles found.