Should You Follow Your Fund Manager?
By Shauna Croome

Staff turnover in the fund management industry is higher than in most industries. There is a good chance that one day your fund manager will no longer be guiding your investments, leaving you to face the question: should I stay or should I go? The whole idea of investing in a mutual fund is to leave stock-picking to professionals. Investors study the performance of mutual funds to search for the winners, the funds run by managers who, year-on-year consistently beat the market and their peers. Comfortable that they have found a winner, investors place a bet for the long term. But often, events don't turn out quite as expected. Often the manager resigns, gets transferred, or dies. A big part of the investor's decision to buy the fund is based on the manager's record, so changes like these can come as an unsettling surprise. Investors are bound to face this kind of troubling situation from time to time. In early 2002, investors with London-based HSBC Unit Trust Funds were left wondering what to do with their holdings after the abrupt departure of five flagship fund managers. Given the market-beating performance the unit trust team had chalked up at HSBC, investors were probably counting on the managers staying put for years to come. Still, investors who stuck with the HSBC fund had little to complain about. Six months later, the fund's successors more than matched the predecessors' record, and investors who stayed have enjoyed strong performance. But not all investors make out as well when managers leave. Another UK fund, Solus Special Situations Fund, topped the sector under manager Nigel Thomas. But, under new manager Nick Greenwood, the fund has performed below the sector average. Mr Thomas, meanwhile, outperformed the sector with his new ABN Amro Select Opportunities fund--that is, until he left it to go to yet another mutual fund. So, which one is typical: the HSBC or the Solus case? There are no rules about what happens in the wake of a manager's departure. It turns out, however, that there is strong evidence to suggest that managers' real contribution to fund performance is highly overrated. Managers are often turned into stars by marketing departments. So when managers move on, it is big news. But investors should not rush to hasty decisions about whether to keep their money in the fund, follow their manager, or change their investment entirely. Funds are promoted on their managers' track records, which normally span a three to five year period. The significance of these records should be taken with a grain of salt. Performance data that goes back only a few years is hardly a valid measure of talent. To be statistically sound, evidence of a managers' track record needs to span twenty years or more. Fund tracking company, Morningstar, compared funds that experienced management changes between 1990 and 1995 with those that kept 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--despite losing any fund managers. Those funds that performed badly in the first half of the nineties continued to do badly, regardless of management changes. A research paper written by Klaas P. Baks, finance professor of Wharton School of Business, shows that the value that managers add is small. Thirty percent of performance can be attributed to managers, seventy percent to the fund. Klaas argues that, while mutual fund management companies will undoubtedly continue to create star managers and tout their past records, investors should stay focused on fund performance. The mutual fund industry looks like a merry-go-round of managers who are jumping around employers at an ever-increasing rate. In the past five years, four out of five funds have changed managers. According to research from Credit Suisse First Boston, thirty percent of funds had a change in management in 2002. That shouldn't worry most investors. Many mutual funds are designed to go through little or no change when a manager leaves. That is because, according to a strategy designed to reduce volatility and succession worries, mutual funds are managed by teams of stock-pickers, who each run a portion of the assets, rather than by a solo manager with co-captains. The American Funds, for instance, manages its funds this way. Some fund groups, like Fidelity, make it a practice to promote successful managers to ever-bigger funds and to quickly get rid of poor performers. Changes are not necessarily a trouble sign. Meanwhile, even so-called star managers are nearly always surrounded by researchers and analysts, who can play as much a role in performance as the manager who gets the headlines. Don't forget that if a manager does leave, the investment is still there. The holdings in the fund haven't changed. It is not the same as a chief executive leaving a company whose share price subsequently falls. The value of the fund will not fall overnight. For investors who worry about management changes, there is a solution: index funds. These investment funds, rather than relying on star managers to actively pick stocks, buy stocks on a benchmark index, like the S&P 500. It doesn't really 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 leave. Most importantly, index fund investors are not charged the steep fees that are needed to pay stars' salaries.

By Shauna Croome