Some days ago, I came across yet another interesting study on manager selection. The idea of this week’s AGNOSTIC Paper is very straight forward. When you hire a fund manager, you want this person to focus on your money and not do much else. Probably no one would agree to a surgery where the surgeon operates on five patients at the same time. So why hire a fund manager who manages more than one fund?
Everything that follows is only my summary of the original paper. So unless indicated otherwise, all tables and charts belong to the authors of the paper and I am just quoting them. The authors deserve full credit for creating this material, so please always cite the original source.
Setup and Idea
The great majority of asset managers offer more than one fund. From their business perspective, this is not surprising. Multiple funds diversify revenue streams, make it easier to raise additional assets, and allow to target a broader set of clients. As a consequence, fund companies usually give their best-performing portfolio managers more than one fund to manage. Such multitasking managers are the focus of this week’s paper.
Apart from the reasons I mentioned above, the authors further explain that responsibility for additional funds is a type of promotion for fund managers. Their salary typically increases with the assets they manage, so responsibility for more funds is an easy way to increase their compensation. In addition to that, allocating more capital to their best-performing employees appears just intuitive for fund companies. If a portfolio manager did a good job with fund A, she should be able to repeat this with fund B. Finally, launching a new fund with fewer assets could actually improve performance. Well-known empirical evidence suggests that portfolio management suffers from diseconomies of scale. Even the best investment processes come with inevitable capacity limits. So if you have talented portfolio managers whose existing funds got too big, it may be a good idea to let them start from zero again.
Bottom line: both portfolio managers and fund companies have logical incentives for multitasking. Of course, the more interesting part for us investors is how manager multitasking ultimately affects the performance of funds. This question is the major focus of this week’s paper. And to give you the key message right upfront: the results are what at least I intuitively expected. You don’t want to have a doctor who treats five patients at the same time…
Data and Methodology
The authors source the data for their analyses from the Morningstar Mutual Fund database. As I mentioned in some previous posts, Morningstar is a standard professional data provider for data on funds and the data quality should therefore be very good. Given that the focus is on multitasking, the authors need to exclude all funds without information about the responsible fund manager. This may be a problem as multitasking certainly also affects purely quantitative or team-manged funds. For this analysis, however, I think it is logical to exclude anonymous funds and the authors certainly did the best they can. The final sample covers 10,325 US open-end mutual funds and 15,833 portfolio managers between 1990 and 2018.
To evaluate the performance of those funds, the authors calculate alphas against the overall US market and the Carhart-4-Factor model which additionally covers Value, Size, and Momentum. They also use Active Share and some other well-established characteristics to examine the funds in more detail.
Important Results and Takeaways
Manager multitasking strongly increased from 1990 to 2018
The authors start with some simple, but very interesting descriptive statistics about multitasking managers. The following chart shows the share of US fund managers who are responsible for more than one fund between 1990 and 2018. In-line with what most of us probably observe in the fund industry on a daily basis, this number increased significantly from about 33% in 1990 to about 50% in 2018.
The authors further explain that managers who start multitasking usually start with just one additional fund. Based on their sample, they also find that 73% of multitasking managers take responsibility for an already existing fund. The remaining 27% launch a new one within the same company. Finally, and this is one of the most shocking statistics to me, only 46% of multitasking managers take on additional funds with the same investment style as their first one. Assuming that they don’t change the style of the overtaken funds, I think this is really striking. Coming back to my doctor example from the beginning, this is like a successful brain-surgeon who, because of his success in that field, starts to do heart-surgeries. It is somehow related and the brain-guy certainly knows more about hearts than the average person, but I would still prefer the specialist.
Managers who start multitasking tend to have better track records
In the next step, the authors examine which type of fund managers start multitasking in the first place. Given the logical arguments for multitasking from the perspective of the fund company (see above), a natural hypothesis is that fund managers who get responsibility for additional funds were more successful in the past.
The empirical evidence supports those arguments. Managers who start multitasking generated significantly higher alphas in the past, attracted more net flow to their funds, and work for larger fund companies. Once again, I think this is quite intuitive. If you own a fund company, you don’t allocate most of your assets to your worst-performing portfolio managers. And if you have a superstar, the hope is that this guy will not only succeed at his first fund but also improves your other offerings.
Fund performance decreases significantly after managers start multitasking
So far, we primarily looked at the perspectives of fund companies and portfolio managers. The more interesting question, of course, is how we as investors can use information about multitasking to make some extra returns or to avoid potential losses.
The authors start with a cross-sectional regression of fund performance on various control variables like past performance, fund size, expense ratio, turnover, manager-tenure, and most importantly, an indicator variable whether the fund manager is multitasking or not. Following the logic of linear regression, the coefficient of this variable captures the performance differences between fund managers who multitask and those who don’t.1Needless to say, under the assumption that all other variables remain constant. And you probably already expect what is coming next. The coefficient on Multitasking is significantly negative. This suggests that multitasking managers underperform their more focused, singletasking, peers. Depending on which alpha estimate you use, this underperformance amounts to 33-43bps per year. Given that even just 1 or 2% long-term alpha is (in my opinion) a very decent result for an active long-only mutual fund, this result is quite substantial and certainly meaningful.
To further isolate the effect of multitasking, the authors next examine the returns of multitasking managers after they began doing it. For that purpose, they simply compare the alphas of fund managers 36 months before and after they start multitasking. The following chart summarizes the results.
The chart already speaks for itself, but the statistical analysis comes to the same conclusion. The alphas of managers decrease significantly after they start multitasking. Depending on the specification, their annual performance decreases by up to 133bps compared to the time when they just managed one fund.
Finally, the authors mention an important limitation of their analysis. There is well-known empirical evidence that the performance of fund managers tend to mean-revert over longer horizons, i.e. good managers of the past tend to do worse in the future. Given that multitasking managers tend to have strong track records (see above), such a mean-reversion could also explain some of the performance decrease. The authors explain that they examined this mechanism in an unpublished analyses and found no such evidence. Yet, they still caution to interpret the impact of multitasking on fund performance as purely causal. In my opinion, this is just intellectual honest.
Bottom line: no matter how you look at it, multitasking in the sense of managing more than one fund tends to hurt performance. Not only do multitasking managers underperform their singletasking peers, they also generate worse returns than during their times with just one fund. So even if you find a very good fund manager who still outperforms after starting to multitask, at least statistically, you still want her to stop it because she would be even better with more focus.
The number of managed funds amplifies the effect of multitasking
Looking at the result above, the next question obviously becomes why the performance of multitasking managers decreases. If a manager spent 100% of his time managing fund A and suddenly splits her time between funds A and B, I think it is reasonable to expect worse performance.2Assuming that the amount of time you put in correlates with the outcome. This is not as obvious as it sounds in a highly stochastic environment like stock markets. But this is a topic for itself… On the other hand, a robust investment process could work across countries and may allow the manager to offer the same strategy in different regional funds without much effort.
To test this Attention channel, the authors no longer use the indicator variable for multitasking. Instead, they re-estimate their regressions with the Number of Funds and Number of Styles a manager is responsible for. The results are in-line with intuitive expectations. Both coefficients are significantly negative and again suggest that multitasking harms performance. Interestingly, the coefficient for Number of Styles turns insignificant in a regression that includes both variables simultaneously. The authors interpret this as evidence that multitasking itself is the problem and not necessarily the variety of task. This speaks against the argument that you can just re-pack a successful investment process into new products without much additional effort.
In some further analysis, the authors also examine several other potential variables for the Attention channel. For example, they find that funds of multitasking managers tend to be less active which again indicates that multitasking managers lack the time to implement differentiated investment ideas. They also find that the impact of multitasking is stronger for research and time-intense funds like small-cap or sector strategies.
Overall, the results all go in the same direction. Multitasking managers apparently don’t have enough time to put in the effort that is required for outperformance. The more funds they manage and the more time-consuming their strategies, the worse it gets.
Investors put less money into existing funds of multitasking managers
Finally, the authors examine how fund investors react to multitasking. We have seen that multitasking hurts performance and is therefore bad for investors. In a rational world, investors should understand this and redeem at least some of their money from multitasking managers. Interestingly, this is exactly what the authors find in their data. Monthly fund flows are significantly lower (though not necessarily negative) for funds with multitasking managers. Depending on the model specification, the difference amounts to 2.7-2.9% per month which is again meaningful.
So investors apparently know about the potential problems and react accordingly. This raises the question why portfolio managers and fund companies sill engage in multitasking. To find an answer, the authors change the observation unit from the individual fund to the portfolio manager. Once they look at the aggregate net flows for each portfolio manager, the coefficient of multitasking turns significantly positive.
What does this mean? Forcing a good-performing fund manager to multitask tends to decrease the flows to her original fund. But this reduction is more than compensated by the higher flows to her new funds. In aggregate, the net flows tend to increase which is exactly what fund companies want to have.
Conclusions and Further Ideas
The main takeaway from this week’s paper for fund investors is of course very obvious. Make sure that your fund managers actually focus on your funds and avoid those who are responsible for a whole bunch of products. In that sense, the number of managed funds and all other responsibilities of the fund manager are definitely points we should add to our checklist for successful asset manager selection.
While the authors only examine the impact of additional funds, I believe the concept of manager multitasking is even more general. Fund managers usually have a variety of responsibilities beyond pure investing. They must talk to existing clients, acquire new clients, manage their teams, if self-employed run their business, some of them publish research, and the list goes on. Looking at the results of this week’s paper, I think it is therefore very important to invest with portfolio managers who actually devote most of their time to investment results. If you find your prospective fund managers on every conference, TV show, or podcast, this is probably a warning sign and you should ask them how much time they actually spend on the portfolio…
Bill [Gates] and I, his father, many years ago, right after we met, had us a group of about 20, write down on a sheet of paper one word that we thought accounted for our success, and Bill and I, we may have met twice, didn’t know what the other one was writing, and we both wrote focus. […] I was focused on investments.Warren Buffett (CNBC Interview 2016, 01:50)
I think people who multitask pay a huge price. They think they’re being extra productive, and I think when you multitask so much you don’t have time to think about anything deeply, you are giving the world an advantage you shouldn’t do, and practically everybody is drifting into that mistake.Charlie Munger (Daily Journal Annual Meeting 2015)
- AgPa #66: Machine-Learned Manager Selection (2/4)
- AgPa #65: Machine-Learned Manager Selection (1/4)
- AgPa #64: Fund Manager Multitasking
- AgPa #63: Fire the Winners and Hire the Losers
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