WHEN THE MUTUAL FUNDS CHANGE MANAGERS

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Intelligent Investing Panel
When Mutual Funds Change Managers
Michael Maiello, 03.06.09, 06:00 AM EST
You know how your fund has performed in the past, but do you know your manager's history? These days, everything's traceable.

When selecting mutual funds, most investors look to past performance.

It's an imperfect indicator of future performance, of course, but it's usually the best data available. At the very least, good performance over a long period of time implies that mutual fund managers have skill.
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But there are problems with the way past returns are reported. First, there's nothing that indicates the effect of manager changes over long-lived funds. Fidelity Magellan has beaten the S&P 500 over the course of its long life as a fund, but it's had many managers (and many legendary ones). Obviously, Peter Lynch's Magellan was different than Harry Lange's or Ned Johnson's or Jeff Vinik's.

This chart, provided by Adviser Investments, shows the effect of a manager change (indicated by red dot) on the Vanguard Capital Opportunity Fund:

capitalopp_chart.gif

Another thing that investors aren't told is what new managers have done at other funds. If you own a fund that gets a new manager, you're left to trust that he or she will follow an old successful strategy or was hired for a good reason. Fund companies don't tell you anything about manager track records.

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All of this is the fault of the Securities and Exchange Commission, not the fund companies. What fund companies can and can't report is tightly controlled. A manager's previous record is forbidden territory.

Mutual fund families are also required to only report performance net of fees, so historic returns don't reflect the effects of fee changes over time. Though fund families are required to inform investors about manager changes, they aren't required to start a fund's record over when a new manager takes over.

Newsletter editor James Lowell joins our panel of experts. He is head of the Rankings Service, a firm that tracks career-long manager performance over multiple funds. You can also trace manager performance yourself. It's a bit tedious, but start with the manager's bio in the fund's fact sheet or prospectus.

Then, backtrack. Past bios probably reveal more about the manager's past fund positions. At that point, it's possible to work out approximate dates of tenure and, with historical return data available free on the Web, to work out performance against a broad benchmark like the S&P 500.


NOTE:JAMES LOWELL he is head of the ranking of serveces and he is good news letter editor.
This week our mutual fund managers discussed issues of disclosure.

The Forbes mutual fund panelists are:

Daniel P. Wiener, editor of Independent Adviser for Vanguard Investors and CEO of Adviser Investments.

Adam Bold, founder and chief investment officer of the Mutual Fund Store.

Richard Gates, portfolio manager for TFS Capital.

Laura Corsell, an attorney with Montgomery, McCracken, Walker & Rhoads specializing in mutual funds, investment management, regulation and compliance.

James Lowell, editor of Fidelity Investor, the Forbes ETF Advisor, ETF Trader and the Rankings Service.

Performance Records

Wiener: The issue of manager changes is a big one, and one not adequately addressed in most disclosure documents or other performance-based documents. A perfect example: Vanguard's Growth Equity fund was run from inception through late last year by a team at Turner Investments. After years of dismal performance, a chunk of the fund was handed over to Baillie Gifford last spring.

Further, Turner was then fired in January of this year, and Jennison Associates was hired, and the fund's assets split fairly evenly between the two management teams. As far as I'm concerned, it's a brand-new fund. Period. Yet it will continue to show horrific one-year, three-year and longer performance numbers. I don't know of anyone putting an asterisk on performance numbers indicating manager changes.

Shareholders receive notification, generally in the fund's annual or semiannual report, but I don't believe there is very good disclosure at all.

Meanwhile, I don't believe funds would be allowed to show prior performance from "other" funds, though this is absolutely the type of research and analysis I do for readers of my newsletter and for clients of Adviser Investments. It's one reason we purchased Vanguard's Capital Opportunity fund one month after Husic Capital was fired and PRIMECAP Management was hired to run the fund--I gave them a month to revamp the portfolio--despite the fact that its historical "numbers" looked horrible for months and years afterwards, even though the PRIMECAP team was going great guns.

NOTE:the fact that its historical "numbers" even thought the PRIMECAP team was going great guns.

Lowell: Calculating the running records of each manager's monthly performances--one can do annual, quarterly, weekly, daily reviews, etc.--relative to highly correlated benchmarks over their total career of managing money is the most accurate way to measure and monitor not only past performance but how that performance was derived during different market cycles and seasons, different objectives and different risk management challenges and requirements. If I can see the extent to which the managers' choices have tended to help, or hurt, fund performance over their career, why isn't it mandatory to disclose this for every investor?

Abigail Johnson, president of Fidelity Personal Workplace and Investing, said, "You do your research, you make your recommendations or you buy your stocks and you live with your moves, and your success or failure against the benchmarks is right out there to be seen."

Johnson has it exactly right. At Fidelity, investing is a batting average business, where batting average isn't good enough. Moreover, it's a business where, despite all the conventional wisdom and services, the batting averages of your individual managers' stock- and/or bond-investing careers matter more than any current rating service or consulting firm can quantify or qualify. As Peter Lynch, former star manager of the once glorious Magellan still quips, "Stock investors need to know what they own."

Today's investors are being ill served by the very sources they turn to for advice. The problem? Morningstar, Lipper or S&P, or many advisory newsletters, all share one fatal flaw: They rate and recommend funds based on the fund's past performance rather than the historical track record of the manager who is currently running the fund.

Since Fidelity has a long-standing history of offering funds run by individual managers, as opposed to anonymous teams of them, and the fact that Fidelity has historically grown its own management talent, culled from the über-competitive environment, it has always been and remains a perfect microcosm for tracking, ranking and buying the manager, not the fund.

Gates: Welcome, James! And, thanks for sharing so much good information about your business. I am interested in knowing whether you have any specific data supporting the claims that manager changes affect fund performance. While I know that it intuitively makes sense, I would love to see numbers showing the impact that such changes have. Do you have anything quantifiable like that? Or, is most of your evidence anecdotal, like the PRIMECAP example that Dan provided below?

Wiener: Mine's not anecdotal. I can send you a chart that shows that the fund was lagging its benchmarks until the change, then, wham, it started to outperform.

Lowell: Plenty of examples in and beyond Fidelity's pale with regard to both missed opportunities of low-star-rated funds with new managers with stellar records, and the cost opportunity of holding on to a fund when a manager with a poor track record takes the helm, etc. (This also plays out on fund firms that, when ranked by the performance of their underlying managers, often reveals misalignments with high impression/low performance and low impression/high performance.)

One example: Fidelity Aggressive Growth. Back in 1999/2000 it was a five-star fund based on manager Erin Sullivan's returns; she was a large-cap growth momentum manager. In 1999 the market handed her some momentum, but she trumped her benchmark index: 103%, vs. 51% for Russell Midcap Growth. She left to start a now defunct hedge fund; her replacement was Rob Bertelson, who had come off of managing Fidelity OTC--benched to the Nasdaq, where he delivered a 72.5% return in 1999. Unfortunately, his benchmark, the Nasdaq, gained 86% that year.

We held Aggressive Growth in our Growth model so the change triggered a deep search of Bertelson's historical track record, where we saw that not only did he consistently fail to be his bench in updrafts, but he had a habit of doing about twice as worse in downdrafts. We said sell. The new president of FMR, Fidelity's fund company, and owner, Abigail Johnson, came out with her first public statement in TheBoston Globe defending their pick of the new manager and questioning my judgment. Barron's picked up the fight.

Long story short, by the time Rob was pulled from the fund, about two years down the road, February 2000 to November 2002, he'd lost shareholders about 85% of their money while his benchmark had lost about 46%--consistent with what we'd seen in his past record, and suggestive that our sell wasn't too off base. Never did hear back from Abigail on that one.

Gates: One fund's manager change is very anecdotal. Just like I would say that analyzing a small subset of Morningstar's analyst reports does not paint a true picture, I think it makes more sense to evaluate the whole universe, or some random subset of the whole universe.

Wiener: But Rich, I don't buy the universe of mutual funds, I buy individual managers. So, I look for great managers with great, long-term track records. If I cared about the whole universe, I'd buy a total market ETF and go home.

Lowell: My sense of the word anecdotal is that it leans towards hearsay. Dan's case in point is just that, and a good one. What I know: Manager by manager, brick by brick, the "anecdotal" turns into the archetypal framework for being able to say, based on our purely quantitative rankings of the universe of active managers, that individual skills, or lack thereof, directly impacts performance meaningfully. And consistently enough to make it at least a necessary second opinion to the blithe and subjective (ruled by committee, input criterion subject to change, etc.) rating services' shared assumption that fund performance histories are more important than manager track records.

Put it another way, when we run the universe of 7,800 managers that account for 99.6% of fund assets, we can confirm that [indexing proponent John] Bogle is right in his assumption that about 80% of active managers fail to beat their benchmarks. Of course, that leaves more than 1,500 who do ... but this latter point is not a great sales pitch for an index guy.

Gates: Anecdotal evidence can be evidence, which may itself be true and verifiable, that is used to deduce a conclusion that does not follow from it, usually by generalizing from an insufficient amount of evidence. For example "my grandfather smoked like a chimney and died healthy in a car crash at the age of 99" does not disprove the proposition that "smoking markedly increases the probability of cancer and heart disease at a relatively early age." In this case, the evidence may itself be true, but does not warrant the conclusion.

So, that is why I think citing individual examples to prove a point is worthless. But my intuition tells me that manager changes are important. And I think that a manager's past success, or lack thereof, at the helm of a different fund probably provides some insight into what she will do at the current fund.

Corsell: Just picking up the thread. and, as the lawyer in the crowd, I want to clarify that any time the identity of an individual portfolio manager changes, a fund must sticker its prospectus to provide the identity and professional background of the new manager. It is also true, however, that funds are generally not permitted to provide information about the past performance of individual managers.

Bottom line, attentive investors are aware of manager changes. but, without the detailed analysis Jim does, there is no way for even a careful investor to track the performance of a single portfolio manager.

Bottom line: Investors to whom gross performance is unavailable--everyone except institutional investors--have limited ability to assess/compare the quality of the service provided by individual portfolio managers in the context of a mutual fund. Before slamming the funds, though, remember that the rules relating to performance presentations are fixed by the SEC. And for as long as funds have been permitted to advertise performance--this was prohibited before 1975--the SEC has held that net performance is king.

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