There are thousands of US mutual funds to choose from. How to narrow down your choices? A new study suggests that by looking at the economic background of a fund’s portfolio manager, investors can gain an edge in sorting future winners from losers.
The takeaway: Managers who come from poorer families tend to beat those who come from wealthy ones.
In fact, the study found, fund managers who come from the top 20% of wealthiest families trailed those who come from the poorest 20% of families by a significant 1.36 percentage points annually, on average, on a risk-adjusted basis. That annual difference would add up to a large difference in cumulative returns for fund shareholders over time.
How the study worked: Co-authors Oleg Chuprinin of the University of New South Wales and Denis Sosyura of Arizona State University looked at all the actively managed US domestic equity funds that were followed by the fund-tracking firm Morningstar from 1975 to 2012. Among other aspects, they excluded funds that were managed by teams of people, culling the universe to 1,762 funds for the study.
The pair then used databases and US Census records to narrow their sample to 416 managers whose family economic backgrounds they could gauge accurately, looking at such sources as employment records, rent rollsand home value assessments.
Among those fund managers, the ones from poorer backgrounds trounced those from ritzy backgrounds over the 37-year span studied.
The study authors suggested two reasons for the performance discrepancy.
First, people from poorer backgrounds find it difficult to get jobs in asset management to begin with. In business lingo, they face higher “barriers to entry.” So, other things being equal, an applicant from a poor background has to be smarter or better qualified than his or her wealthier rival to get a foot in the door.
“Individuals from wealthy families could obtain prestigious jobs using their families’ resources, whereas those from poor families have to rely on skill,” the study surmises.
Second, once hired, the study found, a manager from an economically disadvantaged background tends to get promoted only if he or she outperforms, while a well-heeled rival tends to get promoted for reasons other than performance.
The question is why that’s the case. A manager from a wealthy background may advance through the ranks because of his or her good golf game or due to family connections, of course. Building off this point, one hypothesis was that wealthy-bred managers are likely to be more adept at attracting assets—arguably a weighty consideration for the company, if not fund shareholders.
But the professors douse that idea. “Neither capital flows nor management fees are significantly higher for funds run by wealthy managers,” they say.
Incentive pay might be playing a role. Managers from poor backgrounds may work harder because the extra money they get from outperforming their benchmarks means more to them, relatively speaking, than it does to their cosseted counterparts.
Whatever their motivation, the study found, economically disadvantaged managers tend to trade more frequently, have shorter holding horizons and are less prone to following the investing herd. They are, in other words, “their own people” to a greater extent than the managers from affluent families.
One fascinating finding: The outperformance of the poor-background managers does not decrease over time, even as their own individual wealth would have presumably increased as they continue to oversee their funds. Does the effect of a poor-vs-rich background extend beyond fund managers and into other kinds of investing professionals? There’s no reason to think it doesn’t—something to keep in mind when you are selecting an advisor of any type. If you’re inclined to favor hiring people who come from wealth, you might be doing yourself a disservice.