Do you believe there are star mutual fund managers?

Question

In mutual fund invstment the aim is to beat the index. To this end new strategies are introduced regularly and the current one is to follow the most successful (star) managers. The logic is intuitively very appealing.

The well known firm Citywire conducted a study to identify the current top fund managers in the UK market.and the results were announced a few days ago, They found that in a universe of 900 managers, 12 had beaten the index every year for the last 6 years.

Star managers attrack huge inflows of money to their funds and not surisingly, they become celebrities and paid telephone number salaries, bonuses and share options.

But I have done some calculations. Assuming a 50% chance of beating the index, the probability of 6 wins in 6 years is 1/64, which gives 14 managers (actually a little less because of fund charges), virtually identical with the result of the study. Those 12 star managers , then, were probably just lucky.

I believe in index trackers. And you?

Answer 1

Beyond the traditional method to determine whether a fund beats or lags its individual benchmark, there is a new method to determine whether the fund manager is really making the right decisions.

Marcin Kacperczyk of the University of British Columbia's Sauder School of Business and Clemens Sialm and Lu Zheng of the University of Michigan's Ross School of Business devised a way to benchmark a fund manager against himself.

In their paper, Unobserved Actions of Mutual Funds, analyzed more than 2,500 diversified domestic equity funds over 20 years from the beginning of 1984 through the end of 2003. For each fund, the researchers calculated the performance of its previous published portfolios. They then calculated the difference between the fund's actual performance and its performance if the manager had made no changes.

The question is: Are the stocks the fund manager buys better than the ones he sells? If he's making smart trades, then the fund will outperform its old portfolio. If he's making unwise moves, then it will lag.

Guess what? One of the surprising results was that the average gap for all 2,500 funds was close to zero.

Answer 2

The problem with the study first of is the "index" you cant compare all those funds to one index as a UK Equity Income fund is far different to a UK Smaller Companies fund. Even if they compare to the sector specific indices there are other issues, some funds will have asset allocations which vary considerably to the indices, while other funds such as special situations funds are not typical funds which cannot be directly compared to an indices.

Second as funds become more popular money is pumped into them or when the fund loses popularity money is withdrawn making a fund managers buy/sell assets which he would otherwise not engage do.

Thirdly markets cycle so some types of funds will be exposed to market changes, each fund has a set of primary objectives therefore these constraints will inhibit a fund manager (yes there are funds which allow managers more options and dont dictate stringent controls but these make up the minority of funds)

My point is this dont confuse theory and the real world, and there are lies, damned lies and statistics. Theories are all well and good but many make assumptions that dont hold true or that dont take account for real constraints e.g. fund objectives, and the citywire article is so general that it doesnt really prove anything as very few top managers have been running the same fund for 6 years and as stated above that analysis is too general to act as a fair comparison.

There are star managers e.g Anthony Bolton Fidelity Special Sits he has been a consistent performer in the UK mutual funds industry. There are also many bad managers but thats like any walk of life...sometimes the worst people get paid the most!

As for index trackers you have to consider the market, UK index trackers will be out performed by active funds (those that are good of course) as the market isnt that efficient. On the other hand the US market is extremely efficient therefore index trackers will do far better there.

Hope this helps

Answer 3

There is indeed luck involved. There are however certain funds that have consistantly outperformed the market in general. Many of these funds have done so perhaps not solely because of management ability, but perhaps because of investment philosophy.

If you buy shares in a mutual fund that invests in large cap stocks, your chance of beating the market in general is virtually nil because the large cap stocks are the market. The best you can hope to do is to track the average minus fund expenses.

If on the other hand you buy shares in a fund that let us say invests in energy companies during the bottom of the energy cycle and then sell them at the top, you will beat the market every time. Or if you buy shares in a fund that invests in companies within geographic areas that are expected to have an above average growth rate, you will beat the averages. If you buy shares in a fund that concentrated in under followed companies, again you will beat the averages.

Those are a few examples.

Answer 4

There ought to be outperforming managers. Assuming there is no such thing as skill, an active manager still has one chance in 1024 to beat the market ten years in a row (before costs and fees, of course). Considering that there are thousands of mutual funds, some of them have to outperform... Whether you and I can figure out which funds those are is a trickier question. William Sharpe did some research and found that mutual fund outperformance does persist, but for relatively short periods of time (a fund that outperformed this year is likely to outperform next year, but has a very average chance of outperforming over the next 3-5 years).

Indexing is definitely a good first step, but it's even better when it is helped by tactical asset allocation. Imagine a very simple portfolio: 60% S&P 500, 35% U.S. Tresury bonds, 5% U.S. T-bills with annual rebalancing. Between 1969 and 2004, this portfolio would return 10.86% a year (arithmetic) with standard deviation of 11.38%. Now imagine a very simple policy tweak; at the end of each year, we compute the ratio of New York Stock Exchange capitalization to U.S. GDP. If it is between 0.8 and 1.2, we leave stock-bond mix for the next year at 60-35; it it is below 0.8, we overweigh stocks at 80-15, if it is above 1.2, we underweigh stocks at 40-55. The result is 11.66% average return with 11.27% standard deviation. $100,000 invested in the "static-allocation" portfolio at the beginning of 1969 would grow into $3,068,436 by the end of 2004; the "dynamic-allocation" portfolio would be valued at $3,980,888. Only once in 35 years, at the end of 1972, would the value of the "dynamic-allocation" portfolio be lower that that of the "static-allocation" portfolio...

Answer 5

Problem is, you don't know who is going to be the star manager at the beginning of the 6 years (just like you don't know which number will come up on the roulette wheel). All you know is that before fees, roughly 50% of managers will beat the market, and roughly 50% of managers will be beaten by the market.

Answer 6

no