Performance teammgmtvsindividual bliss

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  • 1. Performance Characteristics of Individually-Managed versus Team-Managed Mutual Funds RICHARD T. BLISS, MARK E. POTTER, AND CHRISTOPHER SCHWARZ he mutual fund industry has expe-This focus on individual managers over- TRICHARD T. BUSSis an associate professor of rienced extraordinaty growth in the looks an important trend in mutual fund man-finance at Babson College last two decades. At the end of 2005, agement, i.e., each year tnore funds are managedin Babson Park, MA. the combined assets of U.S. mutualby groups or teams of individual managers. funds approached S9 trillion, up from S370 bil- Morningstar data hsts "Management Team" orMARK E . POTTERlion in 1984, while the number of individualmultiple individual managers by name for 60%is an associate pmfessor offunds grew from 1,200 to almost 9,000 overof all equity flinds in 2003, up substantially fromfimiice at Babson Collegethe same period (ICI [2006, pp. 7-8]). In 1984, just 30% iti 1992. The SEC s recent rule changesin Babson Park, MA.only 12% of U.S. households owned mutualregarding the disclosure of more informationpotterina@ habson.edu funds, but by 2005, the number had quadru-on the members of management teams high-CHRISTOPHERpled to 48%, representing 54 million U.S. light the importance of this trend to investors.SCHWARZhouseholds (ICI [2006, p. II]). One explanation is that fund companies areis a doctoral candidate Along with this growth came consider-using team management to avoid falhng victimat the University of Massa-to "stars" that leave (Kovaleski [2000]). Another able scrutiny of the managers running thesechusetts in Amhcrst. mutual funds. Those guiding the largest and most explanation is that groups make better decisionschris schwarz@som.umass.edu successflil flinds cotiimanded multi-million dollar in the areas of selecting and managing a stock salaries and appeared on magazine covers andportfolio. television talk shows discussing their invest-In this article, we consider the manage- ment secrets and offering advice. Debates about ment companys choice of individual versus value versus growth strategies, glamor stocks,team management. Specifically, we look at dif- efficient markets, and the pros and cons of ferences in perfortnance, risk, expenses, and indexing were commonplace. Each year, the turnover. The theoretical bases for this analysis "winners" saw the assets they managed groware found in existing research about the dif- exponentially, while the "losers" lost investorsferent processesand the ensuing results or, in extreme cases, were ftred. A large bodyused by individuals and groups to make of academic research has been devoted todecisions. We do not purport to provide insight assessing individual mutual fund managers and into the fund managers decision-making their performance. This research has evaluatedprocess. This question, while certainly inter- the impact of numerous factors on fund per- esting, is beyond the scope of this article. Our fortnance, including the futids size, structure, focus is on discernible differences in the char- and expenses; the age, tenure, educational levelacteristics of individually-managed versus and compensation of the manager; and theteam-managed mutual funds. turnover and risk profile of the fund. 110PEKFORMANCE CHARACTERISTICS OF INDIVIDUALLY-MANAGED VERSUS TEAM-MANAGED MUTUAI. FUNDSSPRING 2008

2. We develop hypotheses and evaluate them using aThe most surprising fmding is that no difierence exists insample of several thousand actively managed domestic and the time it takes groups and individuals to reach a deci-international mutual funds. We fmd that the performancesion, even though in both experiments group decisionsot mutual funds managed by teams is similar to individually- were superior. Miner |1984] used an experiment that testsmanaged funds on a risk-adjusted basis. In spite of this, theevaluative judgment applied to a comple.x problem, a sit-number of team-managed funds has grown at a significantlyuation relatively similar to those faced by mutual fundgreater rate over the past 12 years. When investigated fur-managers. Miner found that groups did a better job, butther, we fmd that team funds have significantly lower risk not better than the best individuals. The problem is thatthan their individually-managed counterparts and exhibit the best individuals could only be identified ex post basedlower cross-sectional differences in their performance and on their performance on the experiment.systematic portfolio factor loadings. We also fmd that team- There are a few popular press and academic arti-managed funds have significantly lower expenses and loadscles on the performance of group and individual mutualthan individually-managed funds. fiand managers. Bloomberg Business Services looked atThe following section reviews the relevant litera- U.S. equity funds from 1982 to 1997, and reported thatture and develops the hypotheses we test, followed by a"multiple-management returns outpaced those ofdiscussion of our data, methodologies, and results. We individually-managed funds by 1.2% per year" (Powersconclude with a summary of our fmdings and suggestions [1997]). They attributed this to better discipline and coop-for future research. eration. A Fortune article found the opposite for the three- year period 1992-1995 reporting that "single-managedLITERATURE REVIEWfunds outperformed team-managed funds by 1.2%, and teams lost in 13 out of 16 categories" (Prochniak [1996]). In an ideal world of classical finance, it should not In the academic arena, Prather, Middleton, andmatter whether groups or individuals are making decisionsCusack [2001], and Prather and Middleton |2(H)21 con-because the goal is the same: to maximize end-of-periodsidered the question of individual versus team managementwealth, or total returns, over a particular time period (Arrow of mutual funds. The first article analyzed 148 Australian11986]). However, the fields of psychology and behavioralinvestment funds from 1993 to 1998, concluding thatfinance, among others, make it clear that groups make deci-there is "no significant risk-adjusted performance differ-sions differently than individuals and in many situationsence between multi-sector trusts managed by teams andproduce better results. Bainbridge [2002] provided anthose managed by individuals." Prather and Middletonexcellent overview of the theoretical differences and[2002] used a sample of 162 U.S. mutual funds for theclearly described why and in what situations groups will period 1981-1994. Their sample consists of 147 fundsmake better decisions. We defer to his work and focusmanaged by individuals and 15 managed by teams. A morefirst on the large body of experimental evidence sup-recent working paper by Baer, Kempf, and Ruenzi [2005]porting this claim.found team-managed funds exhibit marginally lower risk Early findings unrelated to investment management and more persistent returns, and experience greater inflows(Hill 11982]) indicated that groups, on average, make supe-over time.rior decisions compared to individuals. For the groups inOur work extends this prior research in severalthe Hill stLidy, however, interaction was otherwise limited. notable ways. First, our sample is much larger, encompassesClearly, such a limitation is not the case with teams of a long time-period, and has a more balanced proportionfund managers who may interact frequently with one of team-managed and individually-managed funds.another. However, the reason for Hills conclusion may Second, by using a unique dataset that combines the Morn-still applygroups made better decisions due to poolingingstar and CRSP databases, our results are more robustand aggregating disparate pieces of information. In addi-and less susceptible to data errors. Third, we use moretion, VoUrath et al. [1989] found that groups recall infor-current methodologies to evaluate performance and risk.mation more accurately, leading to better-informed In spite of the ambiguous evidence on perfor-decisions. mance to date, we believe the theory and evidence on Blinder and Morgan [2005] used two differentthe superiority of group decision making is compelling.experiments that yielded similar and striking results. Because of this, we expect that, a priori:SPRING 2U08 THE JDURNAL OF PORTFOLIO MANAGEMEN"! Ill 3. mutualfijtadsmanaged by more than one individual to 1999, however, only yearly updates are available.wiU exhibit better performance than mutual funds These two datasets were combined using identifiable keymanaged by a single individual, andfields and hand sorting when necessary, providing a unique because groups make better initial decisions, port-dataset that is as complete and accurate as possible.folio turnover of tnutiial funds managed by groupsNeither of the two datasets provides overall fundWTH be lower than portfolio turnover of mutual funds information, but lists each share class separately. We mergedmanaged by individuals.share classes of funds together to yield a final and complete dataset that consists of all unique tnutual funds. Essentially, Other research (e.g., Isenberg [1986]) has addressedthe data-cotnbining techniques we use in this article aredifferential risk-taking by groups and individuals. Specif-consistent with the approach employed by Daniel et al.ically, groups tiiay exhibit more risk-taking behavior [1997]. To measure fund performance, we rely on thebecause introducing a number of alternatives may lead to approaches used by Carhart [1997], and Chevalier andpolarization toward an option with the most positive argu- Ellison [1999]. A number of factors have been shown toments supporting it, even though it may contain the most infiuence a funds cross-sectional variation in performance,risk. As such, we also expect that including the fund portfolios exposure to a market {p) factor, momentum factor, size factor, and market-to-book mutual funds managed by more than one individualratio