A very common mistake when selecting funds for a defined contribution menu is overemphasizing manager performance without properly considering the risk controls, adherence to style parameters and overall selection process. If a money manager has top decile returns over a given period, does it really matter how they got there? After all, they generated superior returns so why worry about the means to an end? Digging deeper than returns to understand process requires additional effort and professional support, and who has time for that? As anyone who knows me could attest, I often look to sports – specifically soccer – for answers.
The majority of my family, friends and coworkers would not recognize the names of professional midfielders, such as Adam Lallana, Kevin De Bruyne or local team favorite, Antonio Nocerino. These are the players that set up goals and control the game. However, Lionel Messi and celebrated legend Pelé have become household names. Why? They are the goal scorers! The glory hounds, the socialites and the subjects of highlight reels. But was their job of putting the ball into the back of the net more important than the play that put them in the position to do so?
Enter: Fernando Torres. After joining Liverpool FC in 2007, he became the fastest player in club history to score 50 league goals. After much success and scoring 65 goals over 102 games, Torres left the club in January 2011 at the young age of 27 to join rival Chelsea for a British record transfer fee of £50 million. Despite the record fee paid by Chelsea, his goal scoring prowess declined quickly to almost half of his previous production. Many respected pundits believed the difference in team playing style between Liverpool and Chelsea hampered Torres badly.
That is, to duplicate his success, it turns out that how the goals were scored mattered! While phenomenal players can score goals on sheer skill or determination, it is almost impossible to replicate this success without a dependable system. Ideally, a goal is the final step resulting from an efficient team “build up” play, a precise pass that put the striker into the position to score, and yes–a finishing shot past the keeper. The ideal goal is derived from a blueprint, executed by a fully synchronized team. While less glamorized, this type of goal is more consistent, probable and reliable than a fleeting moment of personal brilliance or perhaps just being at the right place at the right time.
This distinction directly applies to selecting funds for your defined contribution plan. For example, sponsors too often select the fund manager they recognize (the goal-scoring superstar!) or the name that appears at the top of the performance list for the quarter. While it may indeed represent a solid fund, one must dig deeper or risk a very common outcome: in the end, the risks that the manager took to get top decile returns are the very risks that increase the chances of bottom decile performance under different market circumstances. Specifically, you may have chosen an outlier without the proper analyst team or supporting structure to replicate results.
Like the best sports programs in the world, participants are looking for consistency from the various “players” in their portfolio. Remember, your participants don’t think about investments every day and certainly aren’t experts. More likely, they consumed the participant education provided during enrollment and selected their fund allocation based primarily on that education. They selected, for example, a large cap growth fund to complement the large cap value fund in their portfolio and did so based on the definitions and instructions you provided. This information may have been delivered online, via print or through the professionals that support your plan, but it is critical that each fund plays the role you defined for participants. This determines if the participant will receive the diversification, consistency and, hopefully, success they need to reach their personal goals.
When it comes to selecting funds for your defined contribution plan, beware selecting the hot manager of the year without proper due diligence and an understanding of their process and risk controls. Successful portfolios, like successful sports franchises, require consistency of style and play. The extra due diligence can make all of the difference between selecting the next Messi or the next Fernando Torres.