I Read Academic Research So You Don’t Have To: What Matters about Fund Managers

by By Ann C. Logue

Business schools are filled with folks who do research in order to gain tenure, pick up a Ph.D., or glean information about the world where they will be working. Often, they dip into the mutual fund data pool for ideas.  

Mutual funds are public companies that have to file extensive operational and performance information with the U.S. Securities and Exchange Commission. Such performance analysis firms as Morningstar divide the funds into categories based on investment style and risk and return profiles, making it easier to do fair comparisons. The result is a huge set of clean data that can be analyzed to learn more about how financial markets work. 

If only it were more readable. Academic research makes a great sleeping aid, but I am one of those crazy people who can stay awake through it. And so, here's the first installment of a semi-regular feature on academic research about mutual funds. This discussion is about fund managers, to give you information to help you weed through prospectuses and fancy brochures from fund companies. 
Want the summary first?: Analysis of mutual fund performance shows that funds with a team manager structure perform best if the group is all women or all men. Research on hedge funds shows that funds run by graduates of elite colleges have better performance.
 
The first study is called "The Impact of Work Group Diversity on Performance: Large Sample Evidence from the Mutual Fund Industry," and it was written by a group including Stefan Ruenzi, a professor at the University of Cologne in Germany, and two graduate students there, Michaela Baer and Alexandra Niessen. It has not been published yet, but the working paper is available at www.ssrn.com/abstract=1017803. 

The authors looked at the effects of manager diversity on fund performance. Diversity, they thought, can be good if it helps people draw on different information networks and points of view, or it can be bad if it causes the team to divide into sub-groups and suffer from miscommunication.  

They checked data on almost 300 team-managed growth funds (those managed by a group rather than a single person; in this study, teams had two to 15 people) between 1996 and 2003. Fund management teams with social-category diversity—that is, a mixture of men and women—performed worse than teams of all men or all women, possibly because of communication differences. Age diversity had no effect. On the other hand, informational diversity, which would be different levels and types of education and fund management experience, increased performance. 

This study followed a similar working paper released in May that looked at the academic backgrounds of hedge fund managers relative to performance. In that paper, "Investing in Talents: Manager Characteristics and Hedge Fund Performances" (available at www.ssrn.com/abstract=990753), authors Haitao Li of the University of Michigan, Xiaoyan Zhang of Cornell University and Rui Zhao of Columbia University found that hedge fund managers who attended colleges with higher average SAT scores had funds with higher risk-adjusted returns, less risky funds and higher cash inflows from investors than funds run by graduates of other institutions.  

What they don't know is if the higher SAT of the manager's college means that the manager is smarter than other managers, if he or she works harder, or if he or she has access to a network of people who can give the fund information. (That's not insider trading, by the way; hedge funds often invest in exotic securities and use complicated strategies, and a fund manager who learns about these investment techniques early may have an edge.) They also looked at fund manager age; they found that younger hedge fund managers had higher risk-adjusted returns and greater cash inflows—while taking on more risk—than other fund managers, possibly because they work harder earlier in their careers. 

Research in hedge funds is more suspect than research on mutual funds. Hedge funds do not have to file with the SEC. Li, Zhang and Zhao used the Lipper TASS database of 4,000 hedge fund managers for their study, but participation is optional: many hedge fund managers don't submit their data unless they are looking for new investors, so they may be different from the average hedge fund manager. And, it's difficult to know if the findings translate to mutual funds, because mutual funds are more conservative and closely regulated than hedge funds. 

When you're a shareholder in a mutual fund, that manager works for you. When you are choosing a new fund or re-evaluating your investment in an existing one, take a look at who the fund managers are. If you find one run by an all-woman team with a variety of experience and degrees from Top 20 colleges, you may just have a winner.

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