It’s not hard to think of a star fund manager whose performance suffered after he or she took on broader responsibilities within the firm. Indeed, the one who probably springs to mind first has openly acknowledged the burden.
‘I look forward to returning my full focus to the fixed-income markets and investing, giving up many of the complexities that go with managing a large, complicated organization,’ Bill Gross said when he joined Janus from Pimco in 2014.
Gross may be the highest-profile example of this trend, but he is far from the only one. In a recent paper, Richard Evans and Marc Lipson of the University of Virginia’s Darden School of Business and Javier Gil-Bazo of the Barcelona Graduate School of Economics examined the phenomenon.
Burden of responsibility
Examining the Center for Research in Security Prices survivorship bias-free mutual fund database from 1997 to 2015, they focused on actively managed, diversified US domestic equity funds. The academics examined the relationship between the alpha generated by a fund manager, subsequent changes to that manager’s duties and their performance thereafter.
The change in a manager’s responsibilities was defined as an increase or decrease in the number of mandates run by that manager. This separated the observed effects from the related tendency of managers’ performance slipping as assets in their fund swell.
The authors framed this as a distinction between scale (managing a large fund) and scope (managing several funds). To take this back to Gross, this reflects the discrete challenges of steering an ever-larger Total Return fund against taking on unconstrained, high yield and low-duration funds.
However, it does mean the research does not incorporate the additional pressures of staff management or investor relations that can accompany success, since this cannot be quantified in the same way as managers running more portfolios.
So, on the first question, are star managers likely to be handed new funds? Yes. ‘We see quite clearly that manager performance, as measured by alpha, is a determinant of later changes in scope of responsibilities,’ reported Evans, Lipson and Gil-Bazo. ‘This result is seen both for expansions and reductions in scope.’
They also noted that independent of a manager’s alpha, those who had proved successful in attracting assets were more likely to see their duties increase too.
Are those managers rewarded with new mandates able to continue delivering alpha? Not so much. ‘Subsequent to the scope expansion or scope reduction, the prior performance is attenuated: there is no further cumulative increase for scope expansions or decrease for scope contractions,’ said Evans, Lipson and Gil-Bazo. ‘Specifically, there is a change in performance that is consistent with a diseconomy of scope.’
Before taking on additional responsibilities, managers in the data set earned a relative alpha of around 8.6 basis points. This fell to 1.18 after their scope increased, which is statistically significant. Conversely, managers who had funds taken away from them were losing 1.8 basis points relative to their peers before their demotion. Their subsequent underperformance fell to just one basis point.
Less is more
‘We find that fund alphas are negatively related to measures of the scope of manager responsibilities: the size of assets managers manage in other funds, the number of other funds managed, and the number of distinct fund investment objectives managed,’ said Evans, Lipson and Gil-Bazo.
‘Taken together, our results suggest that diseconomies of scope may play a role in determining fund performance in a manner similar to the diseconomies of scale,’ they said. ‘As such, our results contribute to the ongoing debate on the value of active management by highlighting another economic force at play that would naturally diminish the value of active management: the expansion of manager responsibilities that might result from outstanding manager relative performance.’
Given the propensity of investors to chase past performance and buy star managers, this creates a dilemma for fund groups – particularly at a time when their margins are under assault from the passive industry.
The best way for active houses to attract flows is to market their best managers, and to seek to leverage their popularity by launching new funds for them. However, doing so impairs their performance.
It is a simpler issue for fund buyers, though: if you hold a manager who starts being granted additional mandates, it is probably time to sell.