Managing Underperformance: A Board’s Obligation to Act in Investors’ Best Interests

In a landscape marked by regulatory intensity and heightened investor expectations, REs and RSEs are increasingly expected to take proactive and objective oversight of the performance of outsourced investment managers. While underperformance alone may not automatically warrant removal, a failure by an RE or RSE board to interrogate, challenge, and respond to persistent or material underperformance may result in a breach of fiduciary and statutory obligations. This article explores the responsibilities of RE and RSEs when managing underperforming investment mandates, and addresses the often misunderstood distinction between seeking a “better performing” manager versus a truly “best-of-breed” replacement.

1. Duty to Act in the Best Interests of Investors

Under s601FC of the Corporations Act, REs have a core duty to act honestly, with due care and diligence, and in the best interests of scheme members. This includes:

Regularly reviewing the performance and conduct of investment managers.
Identifying persistent deviation from benchmarks, risk metrics, or agreed investment style.
Taking appropriate action where the manager’s performance or practices are no longer aligned with investor outcomes.

It is not sufficient for a board to defer to the manager's expertise or allow long-standing relationships to delay intervention. Passive oversight can constitute a failure of duty.

2. Performance Is Necessary — But Not Sufficient

A common pitfall for RE boards is focusing only on short-term underperformance or simple performance rankings. While poor returns are often the catalyst for review, the decision to retain or replace a manager should also consider:

Investment discipline: Has the manager consistently applied its stated process?
Attribution analysis: Is the underperformance explainable and within expected parameters?
Capacity and resourcing: Have there been changes in key personnel or capability?
Style drift: Has the manager moved away from its original mandate?

Boards must ensure performance reviews are holistic and forward-looking, not just reactive.

3. Better Performing vs Best-of-Breed: A Nuanced Decision

When considering a change, the board must go beyond simply selecting a manager who outperformed last quarter or year. Instead, the test should be whether a prospective replacement:

Offers superior long-term risk-adjusted returnsrelative to peers with similar mandates.
Demonstrates institutional strength, governance, compliance and transparency.
Provides clear alignment with the product’s investment objective and risk appetite.
Is likely to deliver sustained value to investors, not just short-term outperformance.

Boards are not expected to find a manager who will always outperform - but they are expected to select from a robust, evidence-based, and well-structured assessment processthat supports the choice of a best-fit provider.

4. Process Over Outcome: Why Documentation Matters

ASIC and APRA both place emphasis on documented governance. If a manager is underperforming and the board chooses to retain them:

There must be a reasoned and defendable basis.
The decision should be recorded, showing consideration of investor impact, alternatives assessed, and mitigations in place.
Performance should be monitored with increased scrutiny, possibly with conditional retention (e.g., under a "watchlist" framework).

Conversely, if a manager is removed, the appointment of a successor must also be documented with diligence - reflecting selection criteria, due diligence findings, cost implications, and transitional planning.

5. Broader Considerations for Replacement

Beyond investment metrics, RE boards should consider:

Tax and transaction impactsof transitioning to a new manager.
Communication strategiesto reassure investors and explain changes.
Ensuring the replacement process does not give rise to conflicts of interest, particularly where RE-related parties may have a financial interest in the replacement.

The board must show that all material considerations have been balanced in reaching their conclusion - not just chasing performance tables.

6. Engaging with Investors and the Regulator

In the context of underperformance or transition:

Investors may expect transparency around performance drivers and governance actions.
ASIC expects that material changes or breaches are disclosed where appropriate.
The RE board should be prepared to demonstrate that its governance processes are fit-for-purpose, repeatable, and focused on investor outcomes.

Conclusion: Good Governance Demands Active Decision-Making

RE boards are not asset managers - but they are responsible for appointing, overseeing, and, when required, replacing those who are. Fiduciary obligations demand that boards act deliberately, objectively, and in the best interests of investors, even where doing so means challenging longstanding relationships or acknowledging past decisions that no longer serve their purpose. In today’s regulatory climate, the question is not simply “is the manager underperforming?” - it is “have we, as a board, taken all reasonable steps to ensure the appointed manager is the best steward of our investors’ capital today and into the future?”

Do you have underperforming managers within your funds? Contact us to discuss how we can assist in performing a review and ensuring reasonable steps are taken to discharge your fiduciary obligations.