An examination of managerial turnover for internally managed and subadvised mutual funds from 1995 to 2009 leads the authors to contend that a focus on subadviser departures provides “sharper” tests of underlying board and sponsor monitoring of mutual fund manager performance. They also address questions left unanswered by previous research.
The authors present findings that enrich investment practitioners’ understanding of the motivation for and consequences of fund manager turnover for sponsors and boards. First, by focusing on largely involuntary subadviser departures, the authors demonstrate how they are able to generate more accurate estimates of the relationships between turnover and other variables, including return performance. Second, they investigate the potential importance of abnormal fund flow (i.e., marketing ability) as an independent predictor of in-house manager turnover. Finally, the authors show that turnover is associated with economically significant increases in future flows for poorly performing funds.
How Is This Research Useful to Practitioners?
The authors find that for tenures of three and six years, the differences in cumulative subadviser departures between top- and bottom-performing subadvised funds are about twice as large as the corresponding differences in cumulative manager departure rates for internally managed funds. Most of the difference between subadvised funds and internally managed funds comes from the lower probability of exits by top-performing subadvisers relative to top-performing in-house managers. This indicates that focusing on outsourced funds effectively eliminates voluntary departures (e.g., promotions) by successful managers.
They define abnormal fund flow in terms of “flow alpha”—abnormal flow after controlling for the fact that flow chases returns. The authors hypothesize that positive abnormal flow could be an indicator of superior marketing ability. They find that internally managed funds suffering from the impact of inferior flow alpha for the prior year (excluding the previous month) tend to replace new managers (i.e., those with tenures of less than three years). According to the authors, the results suggest that funds can identify and eliminate managers with inferior marketing abilities early in their tenures.
The authors examine the relationship between future (subsequent two-year) characteristic-adjusted performance and turnover, controlling for past performance. For both in-house managers and subadvisers, they find little evidence that replacing managers improves future performance. This is consistent with previous research.
Finally, they report that subadvised funds and bottom-performing internally managed funds both experience an increase in abnormal fund flow over the two years following the departures of subadvisers and in-house managers, respectively. For a $10 billion fund, the observed 0.896 standard deviation increase for subadvised funds translates into a projected increase in annual management fees of $1.7 million, assuming a 1% fee.
How Did the Authors Conduct This Research?
The authors obtain data on manager performance and characteristics from several databases. The sample contains 986 domestic, diversified, and actively managed mutual funds for January 1995, increasing to 2,042 funds for December 2009. They construct a subadviser sample encompassing 695 departures. Fund returns are adjusted for exposure to four characteristics: excess market return, size, value, and momentum. The authors use probit regressions to assess the relationships between turnover and prior performance, turnover and prior fund flow, and future performance and turnover for internally managed and subadvised funds.
The authors build a strong case for investors in subadvised funds to track and analyze subadviser departures to minimize the distortion caused by voluntary turnover.
I am intrigued by the notion of abnormal fund flow as an indication of fund manager marketing ability. Although it might be beneficial, from a firm management standpoint, to identify specific manager behaviors (e.g., social media activity) associated with positive flow alpha, it may be even more meaningful to reflect on the ethical implications of pursuing fund flow independently of fund and, ultimately, investor returns.