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Why Fund Managers Matter Research Team | Posted On Wednesday, April 08,2009, 02:03 PM

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Why Fund Managers Matter



The whole thought of investing in a mutual fund is to leave the stock and bond picking to the professionals. Investors revise the performance of mutual funds to search for the winners, the funds run by managers who - year over year - consistently hammer the market and their peers. They have found a winner Comfortable; investors place a bet for the long term.

But habitually, events don't turn out quite as expected - the manager resigns, gets transferred or dies. A gigantic part of the investor's decision to buy a managed fund is based on the manager's record, so changes resembling these can come as an unsettling surprise.

Fund Manager Changes

Investors are tending to face this kind of disturbing situation from time to time. In near the beginning of 2002, investors with London-based HSBC Unit Trust Funds were left wondering what to do with their holdings after the sudden departure of five flagship fund managers. Given the market-beating presentation the unit trust team had chalked up at HSBC, investors were almost certainly counting on the managers staying put for years to come.

Still, investors who stuck with the HSBC fund had minute to complain about. Six months later, the fund's successors more than matched their predecessors' records, and investors who stayed on enjoyed brawny performance.

However not all investors make out as well when managers leave. Another U.K. fund, Solus Special Situations Fund, topped its area under manager Nigel Thomas. But when Nick Greenwood took his place in 2001, the fund performed beneath the sector average. Thomas, in the meantime, outperformed the sector with his new ABN Amro Select Opportunities fund until he left it to go to yet another mutual fund.

So, which one is classic: the HSBC or the Solus case? There are no rules about what happens in the wake of a manager's departure. It turns out, nevertheless, that there is strong evidence to suggest that managers' real contribution to fund performance is highly overestimated. Managers are frequently turned into stars by marketing departments. Therefore, when managers move on, it is big news. But investors should not hurry to speedy decisions about whether to keep their money in the fund follow their manager or change their investment entirely.

Perspectives on Fund Manager Tenure and Performance

Funds are promoted on their managers' track records, which usually span a three- to five-year period. The importance of these records should be taken with a grain of salt. Performance data that goes back only a few years is barely a suitable measure of talent. To be statistically sound, verification of a manager's track record needs to span, at a minimum, 10 years or more.

For instance, Research Company Morningstar compared funds that experienced management changes between 1990 and 1995 with those that reserved the same managers. In the five years ending in June 2000, the top-performing funds of the previous five years tended to keep beating their peers - regardless of losing any fund managers. Those funds that performed shoddily in the first half of the 1990s continued to do badly, regardless of management changes.

The mutual fund industry may appear like a merry-go-round of managers, but that shouldn't be bothered most investors. Many mutual funds are intended to go through little or no change when a manager leaves. That is because, according to a approach designed to reduce volatility and succession fears, mutual funds are managed by teams of stock pickers, who each run a fraction of the assets, rather than by a solo manager with co-captains. The American Funds, for example, manages its funds this way. Some fund groups, like Fidelity, make it a follow to promote successful managers to ever-bigger funds and to swiftly get rid of poor performers. Changes are not essentially a sign of trouble. In the intervening time, even so-called star managers are nearly always surrounded by researchers and analysts, who can play as much of a role in performance as the manager who gets the headlines.

Advice for Investors in Managed Funds

Don't fail to remember that if a manager does leave, the investment is still there. The holdings in the fund haven't distorted. It is not the identical as a chief executive leaving a company whose share price subsequently falls. The value of the fund will not fall immediately. The best thing to do is to monitor the fund more personally to be on top of any changes that hurt its fundamental investment qualities.

In accumulation, don't underestimate the breadth and depth of a fund company's "managerial bench". The larger, established investment companies usually have a large pool of talent to draw on. They are also well conscious that investors are prone to depart from a fund when a managerial change occurs. Morningstar does a good work of tracking changes in fund management, and its opinions on such procedures can be found in the analyst commentary section of its mutual fund reports. Finally, for investors who are bothered about management changes, there is a solution: index funds. These mutual funds buy stocks and bonds that track a yardstick index like the S&P 500 rather than relying on star managers to actively select securities. In this case, it doesn't actually matter if the manager leaves. At the same time, index investors don't have to pay tax bills that come from switching out of funds when managers quit. Most prominently, index fund investors are not charged the abrupt fees that are needed to pay star management salaries.

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