mutual fund performance and governance structure: the role of portfolio managers and boards of...

Mutual Fund Performance and Governance Structure: The Role of Portfolio Managers

and Boards of Directors

Bill Ding, SUNY at Albany

Russ Wermers, University of Maryland (Presenting)November 8, 2012

My New Textbook(Available soon via amazon.com)

April 20, 2023 Mutual Fund Managers and Directors Slide #2


Relevance of Fund Managers The mutual fund performance literature generally ignores

the role of fund managers and fund governance (e.g., Jensen (1968), Grinblatt and Titman (1989), Wermers

(2000), Carhart (1997), and Chen, Hong, Huang, and Kubik (2005))

Stockpicking talents may reside at the managerial level, rather than exclusively at the fund level High compensation [median base plus bonuses (2004) is $340K

—higher than median hedge fund manager compensation] Skill development Relationship development (pre-Regulation FD and post-

Regulation FD)


The Public Perception of Managers

Mutual fund “star” managers are profiled regularly by the Wall Street Journal, New York Times, Bloomberg, and other media sources

Peter Lynch, formerly of Fidelity Magellan has reached almost legendary status

Bill Miller, of the Legg-Mason Value Trust Fund, has beaten the S&P 500 for 15 years in a row—prior to 2007—and became media “star”


Recent SEC Adoption of Enhanced Portfolio Manager Information

On August 18th, 2004, the SEC adopted “Disclosure Regarding Portfolio Managers of Registered Investment Companies,” which requires disclosure of: Manager identity, including “teams” (in fund

prospectus) Name, title, experience with fund, career experience

Other accounts managed by each manager (in SAI) Compensation method for each manager (in SAI) Ownership by fund manager of fund shares (in SAI)


Past Research on Mutual Fund Managers

Manager characteristics and fund risk-taking and performance: Chevalier and Ellison (1997 JPE, 1999 QJE, 1999 JF)

Manager contribution vs. fund contribution to performance (Baks (2004))

Manager changes: Khorana (1996, 2001)


If Fund Managers Matter, then the Following Issues Become Important

Is scarce fund manager talent allocated efficiently in the mutual fund industry?

In an efficient fund manager labor market, Underperforming fund managers get demoted or fired

(and/or suffer outflows) Outperforming fund managers get promoted (and/or

attract inflows) Therefore, more experienced managers (who have

also exhibited better past talents) manage bigger funds


Relevance of Fund Directors In September 2003, New York Attorney General

Eliott Spitzer announced a widespread investigation of mutual funds

As of September 2004, 25 fund families were apparently involved in the market timing and late trading scandals Settlements reached $2 billion

The widespread nature of mutual fund scandals seem to question the effectiveness of fund governance

The board of directors may be an important internal governance force to monitor managers


New SEC Rules on Fund Governance (originally effective September 7, 2004;

currently stayed by the U.S. Court of Appeals) At least 75% of the directors must be independent

Over 80% currently conform to this requirement The board's chairman must be independent

More hotly contested by the industry The board measures (at least annually) the performance of

the board and its committees The independent directors meet at least quarterly in a

session with no interested directors present Independent directors are authorized to hire independent

employees and to retain advisers and experts necessary to carry out their duties


Role of Boards of Directors in Fund Performance

Our Conjecture: When the board is more effective, a fund performs better and the advisor is more likely to discipline managers for underperformance Directors negotiate fund fee contracts with fund advisors (Indirectly) help to select (and fire) fund managers, as well as to

incentivize managers Can argue for increased support for underperforming manager

(e.g., more analysts, co-managers) Prevent family cross-subsidization (a la Massa paper) at the

expense of their fund If so, what are the characteristics of effective boards?


Contributions of Our Study

We provide insight into issues of fund governance: Do independent directors improve the

efficiency of manager labor markets? Do they improve fund performance through

monitoring of fund manager and management company behavior?


Mutual Fund Manager Data Extensive panel dataset of fund managers, 1985

to 2002, compiled from: Morningstar (including M-S Librarian) Thomson/Wiesenberger CRSP (1992-2002) Various mutual fund publications during 1984-91

Mutual Fund Directory of Investment Dealers’ Digest Mutual Fund Profiles of S&P/Lipper (1987-91) Handbook for No-Load Fund Investors (1984-91) Mutual Fund Sourcebook of Morningstar (1984-91)

Archived fund filings from SEC’s Public Reference Room


Summary Statistics on Fundsand Fund Managers

Manager data is matched with stockholdings data from CDA/Spectrum and net returns/characteristics data from CRSP (see Wermers (2000) for description)

Limited to funds having an investment objective of AG, G, GI, I (actively managed, diversified domestic-equity funds)


CS Measure of Magellan Fund

-5

0

5

10

15

20

25

30

35

4019

77

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

Year

CS

Mea

sure

(%/y

ear)

Peter Lynch’s Tenure


1985 1991 1997 2002 1985-2002

All Funds 324

(15%)

648

(3%)

1,594

(5%)

1,698

(10%)

2,689

(4%)Aggressive Growth 70

(14%)

169

(2%)

178

(3%)

276

(8%)

533

(3%)Growth Funds 165

(15%)

345

(4%)

1,129

(6%)

1,137

(10%)

2,084

(4%)Growth and Income

or Income89

(16%)

134

(2%)

287

(5%)

285

(10%)

561

(2%)

Counts of Funds/(Percentage With Missing Managers) (Table I)


Median Fund Manager Characteristics(Table II, Panel A)

Career Experience

(Years)

Career CS Track

Record (% per year)

Proportion of Funds

Experiencing Lead Manager Replacement

(%/year)

1985-1987 4.3 1.21 10.2

1988-1990 4.7 0.65 10.3

1991-1993 4.8 0.88 12.2

1994-1996 4.0 0.72 13.5

1997-1999 4.3 0.16 14.1

2000-2002 5.5 1.46 14.8


Reasons for Manager Replacement (Not in Paper)

Prior 3-Year CS Quintile N TNA Left the Sample Demotion Lateral Promotion

Highest 18 891 56.2% 11.5% 13.5% 13.5%

2 17 1220 59.5% 12.8% 15.2% 5.6%

3 19 712 60.6% 16.9% 12.9% 2.4%

4 23 620 62.4% 12.8% 12.0% 6.8%

Lowest 24 286 67.0% 9.1% 11.1% 7.6%

Average Fund Size ($millions), Segregated by Fund Manager

Characteristics(Table II, Panel B)

Career Track RecordAverage Career Track Record (%/year) 8.70 2.67 0.70 -1.18 -6.49 1.02

Average Career Experience (Years)

Top 20%

2nd 20%

3rd 20%

4th 20%

Bottom 20%

All Lead

Managers

Top 20%-Botto

m 20%

Career Experience

18.5 Top 20% 1,265 2,013 1,491 886 421 1,236 844***8.8 2nd 20% 1,227 723 602 530 308 688 919***5.4 3rd 20% 480 553 606 365 224 445 257**3.3 4th 20% 320 399 311 285 214 306 107

1.3Bottom 20% 234 283 286 202 128 229 106**

8.0All Lead Managers 761 860 699 468 268 617 493***

Top 20%-Bottom 20%

1031***

1730***

1205*** 684*** 293***

1007***April 20, 2023 Mutual Fund Managers and Directors Slide #18


Following-Year CS Portfolio Performance,Largest 20% of Funds

(Table III, Panel A)

Career Track Record

Average Career Track

Record (%/year) 6.88 3.03 1.42 0.17 -2.04 1.91

Average Career

Experience (Years)

Top 20%

2nd 20%

3rd 20%

4th 20%

Bottom 20%

All Funds

Top 20%-

Bottom 20%

Career Experience

24.3 Top 20% 1.87 1.85 1.25 0.46 0.12 1.13 1.75**13.2 2nd 20% 0.62 1.10 0.64 -0.52 0.01 0.39 0.60

8.5 3rd 20% -0.01 0.92 0.38 0.82 0.14 0.48 -0.155.6 4th 20% 0.26 1.08 1.04 1.40 1.42 1.03 -1.162.8 Bottom 20% -0.42 0.79 0.00 0.07 0.63 0.20 -1.05*

10.9 All Funds 0.48 1.18 0.66 0.46 0.46 0.65 0.02

Top 20%-Bottom 20%

2.28* 1.07

1.24** 0.39 -0.51 0.92*


Following-Year CS Portfolio Performance,Smallest 20% of Funds

(Table III, Panel C)

Career Track Record

Average Career Track

Record (%/year) 8.52 2.58 0.10 -2.26 -9.08 0.05

Average Career

Experience (Years)

Top 20%

2nd 20%

3rd 20%

4th 20%

Bottom 20%

All Funds

Top 20%-

Bottom 20%

Career Experience

19.4 Top 20% -0.42 1.09 0.07 -0.92 4.49 0.57 -4.91***8.6 2nd 20% 0.84 0.76 1.11 0.99 0.83 0.92 0.015.1 3rd 20% 4.40 2.38 1.51 1.24 0.56 2.03 3.84**3.2 4th 20% 0.89 2.01 2.21 2.33 0.97 1.65 -0.07

1.7Bottom 20% 0.94 0.64 0.66 1.14 0.17 0.67 0.76

7.5 All Funds 1.30 1.35 1.10 0.97 1.25 1.17 0.05

Top 20%-Bottom 20% -1.36 0.44 -0.59 -2.06** 4.31** -0.10


Dependent Variable: Fund Performance (Year t+1) (Table IV)

Portfolio Alpha (CS) Net Alpha + Expenses Net Alpha(%/year) (%/year) (%/year)

(1) (2) (3) (4) (5) (6)Constant 1.23* 1.14 3.84*** 4.14*** 1.73 1.97

1.87 1.70 3.09 3.21 1.49 1.65Log(TNA) -0.21** -0.22** -0.58*** -0.60*** -0.40** -0.42**

-2.67 -2.74 -3.77 -3.84 -2.78 -2.88

EXPER -0.029 -0.021 -0.11** -0.14**-

0.14***-

0.16***-0.89 -0.59 -2.28 -2.51 -2.97 -3.17

CST 0.18** 0.18** 0.081 0.090 0.11 0.122.21 2.19 0.74 0.81 1.02 1.07

Log(TNA)×EXPER 0.0093* 0.011** 0.019** 0.018**0.023*

** 0.021**1.90 2.38 2.42 2.29 3.04 2.90

Log(TNA)×CST -0.030** -0.031*0.00002

0 -0.0015 -0.0063 -0.0075-1.98 -1.98 0.00 -0.08 -0.32 -0.39

NUMFUNDS_ADVISOR×EXPER -0.0017 0.0063* 0.0055*

-1.06 1.93 1.85

NUMFUNDS_ADVISOR 0.030***0.041**

* 0.035** 0.00390.034**

* 0.00573.35 3.14 2.83 0.19 2.91 0.28

Avg. N 778 778 771 771 785 785Avg. Adj. R2 0.04 0.04 0.04 0.04 0.04 0.04


Director Data

We collect director data for 1995, 1999, and 2002 (Lipper provided 2002) Total number of directors for each fund Number of outside directors Whether board chair is insider or independent


Harris and Raviv (2005)Theory of Board Structures

For boards that are majority outsider (by regulation), additional outsiders only play an additional information-gathering role Too few outsiders means incentive for more

information collection Too many outsiders means each outsider has

increasing free-rider problem Optimum number of outsiders: benefits of collecting

incremental information equals costs (for each outside director)


Summary Statistics on Board Characteristics(Table VI)

Panel A: 1995 Board Characteristics

(1) All Funds

(N=1107)

(2) Management

Turnover (N=98)

(3) No Management

Turnover (N=1009)

p-Value for Difference

between (2) and (3)

Mea

nMedia

n Mea

nMedia

n MeanMedia

n t-Stat WilcoxonNUMDIR 7.6 7.0 8.5 8.0 7.6 7.0 0.00 0.00NUMINDEP 5.5 5.0 6.3 6.0 5.4 5.0 0.00 0.00NUMINSIDER 2.1 2.0 2.2 2.0 2.1 2.0 0.33 0.31

FRACINDEP0.71

4 0.7140.73

1 0.750 0.713 0.714 0.14 0.16

INSIDERCHAIR0.59

8 1.0000.58

2 1.000 0.600 1.000 0.73 0.77

INSIDERLEAD0.86

2 1.0000.86

7 1.000 0.861 1.000 0.87 0.92

INDEPCHAIR0.04

5 0.0000.04

1 0.000 0.046 0.000 0.83 0.94

UNITARY0.83

7 1.000 0.77

6 1.000 0.843 1.000 0.08 0.27

Panel C: 2002 Board Characteristics

(1) All Funds

(N=1443)

(2) Management

Turnover (N=139)

(3) No Management

Turnover (N=1304)

p-Value for Difference

between (2) and (3)

Mean Median Mean Median MeanMedia

n t-Stat WilcoxonNUMDIR 8.2 8.0 9.8 10.0 8.0 7.0 0.00 0.00NUMINDEP 6.2 6.0 7.5 8.0 6.1 6.0 0.00 0.00NUMINSIDER 2.0 2.0 2.3 2.0 1.9 2.0 0.00 0.00

FRACINDEP0.75

4 0.750 0.767 0.769 0.752 0.750 0.11 0.03

INSIDERCHAIR0.49

8 0.000 0.504 1.000 0.497 0.000 0.88 0.90

INSIDERLEAD0.73

8 1.000 0.612 1.000 0.752 1.000 0.00 0.01

INDEPCHAIR0.17

9 0.000 0.295 0.000 0.166 0.000 0.00 0.01

UNITARY0.84

5 1.000 0.885 1.000 0.840 1.000 0.17 0.39

Correlations Between Board Characteristics (1995, 1999, and 2002)

Panel D: Pearson Correlations of Board Characteristics Variables (Averaged Across Years 1995, 1999, and 2002)

NUMDI

RNUMINDE

PNUMINSIDE

R FRACINDEP INSIDERCHAIR INSIDERLEAD INDEPCHAIRUNITAR

YNUMDIR 1.00 NUMINDEP 0.94 1.00NUMINSIDER 0.62 0.31 1.00FRACINDEP 0.11 0.43 -0.67 1.00INSIDERCHAIR 0.09 0.03 0.18 -0.15 1.00INSIDERLEAD 0.00 -0.09 0.19 -0.29 0.54 1.00INDEPCHAIR 0.08 0.13 -0.08 0.20 -0.36 -0.64 1.00UNITARY -0.09 -0.12 0.02 -0.10 0.00 0.01 -0.05 1.00



Logit Regressions of Manager Replacement (Pooled Years 1995, 1999, and 2002, Table VII)

(1)Prior 3-yearα +expense<0 and manager

experience<10 years


experience<10 years


experience>=10 years


experience>=10 years

(5)Prior 3-yearα <0 and

manager experience<

10 years


manager experience<

10 years


manager experience>=

10 years


manager experience>=1

0 years

Intercept -1.51*** -1.60*** -4.07*** -4.15*** -1.92*** -1.99*** -5.45*** -5.61***(-2.63) (-2.69) (-5.09) (-5.09) (-3.82) (-3.82) (-6.34) (-6.25)

NUMINDEP 0.02 0.01 0.17* 0.13 0.03 0.02 0.19** 0.15**(0.47) (0.19) (1.92) (1.45) (0.65) (0.40) (2.55) (2.04)

D75% 0.23 0.51 0.18 0.61(0.86) (1.11) (0.73) (1.41)

INSIDERLEAD -0.39 -0.35 -0.05 0.04 -0.28 -0.25 0.37 0.45(-1.49) (-1.33) (-0.08) (0.06) (-1.20) (-1.05) (0.62) (0.76)

UNITARY -0.57* -0.56* 0.23 0.18 -0.50* -0.49* 0.59(-1.94) (-1.88) (0.45) (0.37) (-1.88) (-1.83) (1.13)

Doutflow 0.81*** 0.80*** -0.13 -0.18 0.97*** 0.96*** 0.25 0.21(2.93) (2.85) (-0.35) (-0.50) (3.95) (3.86) (0.70) (0.60)

Log(TNA) -0.05 -0.05 0.07 0.08 -0.04 -0.04 0.07 0.07(-0.79) (-0.71) (0.68) (0.72) (-0.71) (-0.67) (0.74) (0.76)

NUMFUNDS_ADVISOR 0.01** 0.01** -0.01 -0.01

0.01*** 0.01***-0.004 -0.01

(2.47) (2.38) (-0.69) (-0.78) (2.90) (2.83) (0.65) (-0.62)DYEAR=1995 -0.02 -0.03* 1.06* 1.05* -0.11 -0.11 1.03* 1.04**

(-0.05) (-0.09) (1.95) (1.90) (-0.40) (-0.41) (1.95) (1.97)DYEAR=1999 -0.53* -0.55** 0.27 0.30 -0.42* -0.43* 0.54 0.56

(-1.92) (-2.00) (0.49) (0.61) (-1.74) (-1.78) (1.12) (1.18)Total Number 628 628 320 320 822 822 415 415Number with Replacement 91 91 30 30 112 112 34 34

MacFadden R2 0.07 0.07 0.05 0.05 0.07 0.07 0.05 0.06

Regressions of Fund Performance on Governance Variables (Table VIII)

Portfolio Performance (CS) (%/year)

Net Alpha + Expenses(%/year)

Net Alpha(%/year)

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

Intercept-

4.88***-

3.44***-

3.43***-

3.03*** 0.22-

2.17***

-2.02**

* -1.03 -1.89

-4.14**

*

-3.97**

*

-3.08**

*-3.50 -6.09 -6.03 -4.31 0.15 -3.45 -3.19 -1.30 -1.29 -6.73 -6.44 -3.93

Log(TNA) 0.18** 0.12 0.12 0.12 -0.054 -0.14 -0.17* -0.17* 0.066 -0.011 -0.040 -0.0462.32 1.58 1.53 1.49 -0.63 -1.55 -1.83 -1.91 0.79 -0.12 -0.45 -0.52

NUMINDEP 0.18** 0.18** 0.17**0.24**

* 0.16* 0.14*0.22**

* 0.14* 0.122.53 2.30 2.18 3.07 1.99 1.72 2.77 1.64 1.39

FRACINDEP 3.21 -2.53 -2.431.56 -1.20 -1.15

D75% -0.85* -0.60* -0.61*-

0.61*** -0.46-

1.35***

-1.43**

*

-1.45**

* -0.48

-1.31**

*

-1.39**

*

-1.41**

*-1.73 -1.76 -1.77 -1.80 -0.87 -3.64 -3.84 -3.90 -0.91 -3.53 -3.75 -3.80

INSIDERCHAIR -0.51* -0.59* -0.58* -0.56* -0.12 -0.15 -0.0310.001

4 -0.14 -0.16 -0.039 -0.010-1.63 -1.89 -1.83 -1.79 -0.34 -0.44 -0.09 0.00 -0.40 -0.49 -0.11 -0.03

UNITARY -0.40 -1.00** -0.91*-0.99 -2.05 -1.87

NUMFUNDS_ADVISOR 0.0023 0.0030

0.026***

0.028***

0.028***

0.029***

0.25 0.32 2.59 2.75 2.76 2.90

DYEAR=1995 2.48*** 2.48*** 2.49*** 2.47*** 2.55*** 2.67***2.71**

*2.67**

*2.74**

*2.85**

*2.89**

*2.85**

*7.65 7.67 7.67 7.61 5.52 5.78 5.87 5.78 5.93 6.17 6.27 6.18

DYEAR=1999 0.64* 0.72* 0.72* 0.72* 3.36*** 3.54***3.54**

*3.54**

*3.49**

*3.65**

*3.65**

*3.65**

*1.63 1.84 1.84 1.85 9.10 9.54 9.54 9.56 9.48 9.88 9.87 9.89

N 3,273 3,273 3,273 3,273 3,273 3,273 3,273 3,273 3,273 3,273 3,273 3,273Adj. R2 0.01 0.01 0.01 0.01 0.03 0.03 0.03 0.03 0.03 0.03 0.03 0.04



Summary of Director Results

Underperforming managers are more likely to be replaced with boards having more independent directors When manager has at least 10 years experience Flows and management company only effective for replacing

managers with less than 10 years experience

Funds with larger numbers of independent directors tend to perform better Over 75% tends to decrease performance

Insiders better monitor “hidden actions” Only weak evidence that inside chair impacts performance

mutual fund performance and governance structure: the role of portfolio managers and boards of...

Documents

fund manager of fund

role of fund managers

underperforming fund

saimutual fund managers

fund contribution

fund managers matter

fund risktaking

fund prospectusname