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NewsMaterial3 min readDisconfirmAI Editorial

Investment Columnist Klement: Underperforming the Benchmark Significantly Increases Termination Probability, Outperformance Does Not Ensure Job Security—How Career Risk Distorts Fund Manager Behavior

Klement cites empirical research on Italy’s occupational pension independent management accounts, revealing the asymmetric termination risk faced by fund managers: underperforming the benchmark significantly and rapidly increases the probability of being fired, while outperformance does not reduce this risk. He explains how this mechanism leads to beta suppression and active risk contraction, causing pension funds to pay active management fees for semi-active portfolios.

2026-10-21 14:00 GMT+8

Those who have worked on the buy side know that career risk is real; it often overrides investment judgment itself. However, turning this intuition into a testable proposition is quite difficult because public investment funds are subject to numerous confounding factors, making it hard to isolate the independent impact of career risk on managers' decisions.

Klement argues that the separate managed accounts (SMAs) of Italian occupational pensions provide a rare, clean setting. A single fund manager serves one client (the pension fund) with a clear objective: managing the portfolio in a specified manner. This simple one-to-one relationship allows researchers to isolate the true drivers behind a pension fund's decision to replace a manager or terminate an account.

He references a study by Lucia Spotorno and Giacomo Nocero using a hand-collected dataset of Italian occupational pension fund SMAs from 2003 to 2023. Klement admits that he usually frowns upon seeing phrases like 'hand-collected dataset' in an abstract, but he immediately acknowledges that SMAs are inherently private information, leaving no other way to access the data.

The core finding of the study is asymmetry: underperforming the benchmark significantly and quickly increases the probability of termination, whereas outperforming the benchmark does not reduce the risk of being fired. Klement suggests that the deal offered by pension funds to fund managers literally means 'heads, I win; tails, you lose.'

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Faced with this asymmetry, fund manager behavior aligns perfectly with expectations. They focus on preventing downside risk, pushing portfolio beta below 1.0 so that losses are smaller than the benchmark's during bear markets. Simultaneously, they compress their deviation from the benchmark, reducing active risk. The result is that pension funds nominally hire active managers but effectively receive semi-active portfolios.

Klement also points out an amplifier: this behavior becomes even more pronounced when the same mandate is split among multiple managers. Because managers know they are easier to replace if another manager can seamlessly take over their portfolio, the incentive to conform intensifies.

Performance fees do not work in this structure. Klement explains that performance fees are uncertain, while career risk is certain and concerns job security. An uncertain bonus cannot hedge against a definite threat of unemployment. Consequently, performance fees constitute only a small fraction of total fees, and managers continue to run accounts with lower-than-market activity levels and a more defensive posture.

It should be noted that this is Klement's interpretation and extension of a specific study, not his own empirical work. The data comes from Italian occupational pensions, covering the period 2003 to 2023, within a highly specialized account structure. The study itself does not answer whether this mechanism applies to open-end mutual funds or other legal frameworks of delegation. However, for anyone holding assets indirectly through fund managers, it at least explains a phenomenon that has long puzzled principals: why paying for active management yields portfolios that increasingly resemble indices.

Sources

  • klementoninvesting.substack.com↗
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