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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). Relevance of Fund Managers.

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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
My New Textbook(Available soon via amazon.com)

Mutual Fund Managers and Directors


Relevance of fund managers
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)

Mutual Fund Managers and Directors


The public perception of managers
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”

Mutual Fund Managers and Directors


Recent sec adoption of enhanced portfolio manager information
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)

Mutual Fund Managers and Directors


Past research on mutual fund managers
Past Research on Mutual Fund Managers Information

  • 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)

Mutual Fund Managers and Directors


If fund managers matter then the following issues become important
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

Mutual Fund Managers and Directors


Relevance of fund directors
Relevance of Fund Directors Important

  • 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

Mutual Fund Managers and Directors


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

Mutual Fund Managers and Directors


Role of boards of directors in fund performance
Role of Boards of Directors September 7, 2004; currently stayed by the U.S. Court of Appeals)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?

Mutual Fund Managers and Directors


Contributions of our study
Contributions of Our Study September 7, 2004; currently stayed by the U.S. Court of Appeals)

  • 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 Managers and Directors


Mutual fund manager data
Mutual Fund Manager Data September 7, 2004; currently stayed by the U.S. Court of Appeals)

  • 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

Mutual Fund Managers and Directors


Summary statistics on funds and fund managers
Summary Statistics on Funds September 7, 2004; currently stayed by the U.S. Court of Appeals)and 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)

Mutual Fund Managers and Directors


Peter Lynch’s Tenure September 7, 2004; currently stayed by the U.S. Court of Appeals)

Mutual Fund Managers and Directors


Counts of funds percentage with missing managers table i
Counts of Funds/(Percentage With Missing Managers) September 7, 2004; currently stayed by the U.S. Court of Appeals)(Table I)

Mutual Fund Managers and Directors


Median fund manager characteristics table ii panel a
Median Fund Manager Characteristics September 7, 2004; currently stayed by the U.S. Court of Appeals)(Table II, Panel A)

Mutual Fund Managers and Directors


Reasons for manager replacement not in paper
Reasons for Manager Replacement September 7, 2004; currently stayed by the U.S. Court of Appeals)(Not in Paper)

Mutual Fund Managers and Directors


Average fund size millions segregated by fund manager characteristics table ii panel b
Average Fund Size ($millions), September 7, 2004; currently stayed by the U.S. Court of Appeals)Segregated by Fund Manager Characteristics(Table II, Panel B)

Mutual Fund Managers and Directors


Following year cs portfolio performance largest 20 of funds table iii panel a
Following-Year CS Portfolio Performance, September 7, 2004; currently stayed by the U.S. Court of Appeals)Largest 20% of Funds (Table III, Panel A)

Mutual Fund Managers and Directors


Following year cs portfolio performance smallest 20 of funds table iii panel c
Following-Year CS Portfolio Performance, September 7, 2004; currently stayed by the U.S. Court of Appeals)Smallest 20% of Funds (Table III, Panel C)

Mutual Fund Managers and Directors


Dependent variable fund performance year t 1 table iv
Dependent Variable: Fund Performance (Year t+1) September 7, 2004; currently stayed by the U.S. Court of Appeals)(Table IV)

Mutual Fund Managers and Directors


Director data
Director Data September 7, 2004; currently stayed by the U.S. Court of Appeals)

  • 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

Mutual Fund Managers and Directors


Harris and raviv 2005 theory of board structures
Harris and Raviv (2005) September 7, 2004; currently stayed by the U.S. Court of Appeals)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)

Mutual Fund Managers and Directors


Summary statistics on board characteristics table vi
Summary Statistics on Board Characteristics September 7, 2004; currently stayed by the U.S. Court of Appeals)(Table VI)

Mutual Fund Managers and Directors


Correlations between board characteristics 1995 1999 and 2002
Correlations Between Board Characteristics (1995, 1999, and 2002)

Mutual Fund Managers and Directors


Logit regressions of manager replacement pooled years 1995 1999 and 2002 table vii
Logit Regressions of Manager Replacement 2002)(Pooled Years 1995, 1999, and 2002, Table VII)

Mutual Fund Managers and Directors


Regressions of fund performance on governance variables table viii
Regressions of Fund Performance 2002)on Governance Variables (Table VIII)

Mutual Fund Managers and Directors


Summary of director results
Summary of Director Results 2002)

  • 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 Managers and Directors


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