Evaluating a Portfolio Manager

Evaluating a Portfolio Manager

Evaluating a Portfolio Manager

Evaluating a Portfolio Manager

The ultimate purpose of evaluating a portfolio manager is almostalways a conclusion about his superiority or inferiority. Clearly, themeasurements of performance, period by period, which have been discussed are the raw materials for this ultimate judgement; but, equallyclearly, they do not automatically lead to it. The problem exists because performance in any period is affected not only by the skill ofthe portfolio manager but also by random influences. Just as in acceptance sampling, one typically does not reject a supplier because ofone deficient batch or unit, so an investor should not reject or discardan adviser because of poor performance in any single period. Contrari wise, the investor should be slow to distribute gold stars or enlargedresponsibilities on the basis of superior performance in any one period.

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There is an interesting question as to when the investor is justifiedin reaching the conclusion that his trustee or adviser istruly superioror inferior. There is no completely satisfactory answer to that question,but the judgement can be reached sooner and with greater confidenceif the margins of superiority or inferiority are large and stable thanif they are small and erratic. The principles of sequential sampling which have proved so useful in acceptance sampling for mass-produced items in industry might also be applied here.

Some investorsundoubtedly will be satisfied with a simple evalua tion of the skill with which their trustee or investment adviser hasmanaged a portfolio. If the evaluation is favorable, the investor canrelax and congratulate himself on his wise choice. If the evaluation is unfavorable, the investor can seek a new trustee or new adviser.He may not want to understand the causes for his adviser's successor failure.

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Most large investors and especially most large trustors of employeepension plans are not content with a mere summary evaluation andwish to understand the causes. Such an understanding may be justas helpful in achieving better performance as a switch to another adviser or trustee believed to have greater investment ability. In fact,if evidence concerning the likelihood that superior performance inany one period will be followed by superior performance in a subsequent period is taken seriously, understanding the causes of investmentperformance will do more to improve it than switching from onetrustee or adviser to another.

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