Investments, tenth edition

 Should You Follow Your Fund Manager? 

 The whole idea of investing in a mutual fund is to leave 

the stock and bond picking to the professionals. But fre-

quently, events don’t turn out quite as expected—the 

manager resigns, gets transferred or dies. A big part of 

the investor’s decision to buy a managed fund is based on 

the manager’s record, so changes like these can come as 

an unsettling surprise. 

 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 the managers’ real con-

tribution to fund performance is highly overrated. For 

example, research 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 per-

formed badly in the first half of the 1990s continued to do 

badly, regardless of management changes. While mutual 

fund management companies will undoubtedly continue 

to create star managers and tout their past records, inves-

tors should stay focused on fund performance. 

 Funds are promoted on their managers’ track records, 

which normally span a three- to five-year period. But per-

formance data that goes back only a few years is hardly a 

valid measure of talent. To be statistically sound, evidence 

of a manager’s track record needs to span, at a minimum, 

10 years or more. 

 The mutual fund industry may look like a merry-go-

round of managers, but that shouldn’t worry most inves-

tors. 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. Meanwhile, even 

so-called star managers are nearly always surrounded by 

researchers and analysts, who can play as much of a role in 

performance as the manager who gets the headlines. 

 Don’t forget that if a manager does leave, the invest-

ment 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 best 

thing to do is to monitor the fund more closely to be on 

top of any changes that hurt its fundamental investment 

qualities. 

 In addition, don’t underestimate the breadth and depth 

of a fund company’s “managerial bench.” The larger, 

established investment companies generally have a large 

pool of talent to draw on. They are also well aware that 

investors are prone to depart from a fund when a manage-

rial change occurs. 

 Lastly, for investors who worry about management 

changes, there is a solution: index funds. These mutual 

funds buy stocks and bonds that track a benchmark index 

like the S&P 500 rather than relying on star managers to 

actively pick securities. In this case, 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 star management salaries. 

 Source: Shauna Carther, “Should You Follow Your Fund 

 Manager?”   Investopedia.com   ,  March 3, 2010. Provided by  Forbes.  

 WORDS FROM THE STREET 

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 In practice, evaluating hedge funds poses considerable practical challenges. We will 

discuss many of these in Chapter 26, which is devoted to these funds. But for now we can 

briefly mention a few of the difficulties:

    1.  The risk profile of hedge funds (both total volatility and exposure to relevant 

 systematic factors) may change rapidly. Hedge funds have far greater leeway than 

mutual funds to change investment strategy opportunistically. This instability makes 

it hard to measure exposure at any given time.  

   2.  Hedge funds tend to invest in illiquid assets. We therefore must disentangle liquidity 

premiums from true alpha to properly assess their performance. Moreover, it can be 

difficult to accurately price inactively traded assets, and correspondingly difficult to 

measure rates of return.  

   3.  Many hedge funds pursue strategies that may provide apparent profits over long 

periods of time, but expose the fund to infrequent but severe losses. Therefore, very 

long time periods may be required to formulate a realistic picture of their true risk–

return trade-off.  

   4.  Hedge funds have ample latitude to change their risk profiles and therefore consid-

erable ability to manipulate conventional performance measures. Only the MRAR 

is manipulation-proof, and investors should urge these funds to use them.  

   5.  When hedge funds are evaluated as a group, survivorship bias can be a major 

 consideration, because turnover in this industry is far higher than for investment 

companies such as mutual funds.    

 The nearby box discusses some of the misuses of conventional performance measures 

in evaluating hedge funds.