The best of the best?

A few years ago, the Alaska Permanent Fund (APF) – Alaska’s sovereign wealth fund with assets of USD 50+ bn (website) – introduced an interesting element into their portfolio. After an exhaustive search, they appointed five asset management firms as external CIOs. They gave each about USD 500 million in a largely unconstrained mandate (the only constraints being no real estate and no lockups longer than two years). The winners were AQR, Bridgewater, GMO, Goldman Sachs AM and PIMCO – no surprises there. The winners were expected to provide access to their senior investment professionals and report regularly in person – this is the CIO element. Their return target is five per cent above the US CPI.

At the time, I found the exercise very interesting and innovative. I also hoped that it would succeed. Failure would be very discouraging for anybody who believes that active management makes sense for some well-informed investors. If a very large fund, assisted by a well-known consultant, cannot reliably identify the best of the best among asset managers, then who can? And if the best of the best cannot beat a benchmark that they had accepted at the outset with an unconstrained mandate, then who can we expect to consistently beat their benchmark?

But the results have been mixed, at best. For the three years to the end of June, 2013 (the fund’s fiscal year end), the annualised returns ranged from 5.1 per cent (GMO) to 12.9 per cent (Bridgewater) with the benchmark return at 7.3 per cent. PIMCO was the other manager lagging the benchmark.

It is, of course, not unusual to review managers after three years. But I must admit that I was surprised that the APF subsequently fired GMO and PIMCO, officially for reasons other than just performance. It does not speak well for their confidence in their manager selection capabilities (or in their consultant, for that matter) if they fire managers at the first opportunity. For the three years ending in June 2013, one would have expected to have gotten worse performance from PIMCO, who will have had a bond bias, and GMO, with their profound quality-value bias, than from the others.

The APF will have been pleased with the performance of their remaining external CIOs in fiscal 2014. All three outperformed the CPI+5 benchmark by at least six per cent. But nevertheless, being left with just three survivors out of five after only three years is not very impressive. Another nail in the coffin of active management?