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Not All Manager Changes Are Equal

Some manager replacements are more hopeful than others.

Janet Yang, CFA, 03/12/2013

Portfolio manager turnover often raises a red flag. It's not uncommon, for example, for plan sponsors of 401(k) or pension plans to have written policies that put funds on a watchlist--a penalty box of sorts--whenever there's a change at the helm. There's good reason for doing so. When a good manager leaves or retires, it can be the beginning of a fund's slide into mediocrity, or worse. It can also lead to strategy changes or indicate that there's something bigger going on at the firm.

But that's not always the case. Morningstar analysts have no formal watchlist, but we often put the Analyst Ratings of funds that have changed skippers under review. After further due diligence, we sometimes find the change is an improvement. The following examples demonstrate some instances in which a shakeup at the top actually improves a fund's prospects.

One Fund's Pain Is Another's Gain
A manager's departure may justify a fund's downgrade, but that manager's appearance at a different fund may be a positive development there. Laudus Growth Investors US Large Cap's LGILX Analyst Rating went to Neutral from Bronze when its lead manager Lawrence Kemp left its subadvisor UBS AG UBS to take over BlackRock Capital Appreciation MDFGX. The move may be good news for Capital Appreciation, though.

The Laudus fund gained an annualized 5.8% while Kemp ran it from February 2002 through November 2012, beating the typical large-growth fund's 2.6% and the Russell 1000 Growth Index's 3.6%. Meanwhile, BlackRock Capital Appreciation turned in mediocre results for about a decade under managers Jeffrey Lindsey and Ed Dowd. During their tenure from late 2002 through the end of 2012, the fund's annualized gain of 7% was just middling compared with peers and slightly lagged the index's 7.5% return.

Kemp's arrival is encouraging, but Morningstar analyst Dan Culloton kept Capital Appreciation's People pillar score and overall rating at Neutral because Kemp wasn't exactly a one-man show at UBS and he's still assembling a new team at BlackRock. Until that transition is complete, it's better to watch and wait.

Keeping Things Fresh
With an average fund manager tenure of 11 years and firm tenures that are even longer, American Funds is hardly synonymous with manager churn. The firm's target-date funds have been somewhat of an anomaly among a normally more stable fund lineup. At the beginning of 2012, Wesley Phoa and Bradley Vogt joined the oversight committee in charge of these funds, replacing Joyce Gordon, one of the fund's original architects (Gordon remains at the family as a portfolio manager). Then at the beginning of this year, Andrew Suzman replaced Nicholas Grace, another original cast member from the fund's 2007 launch (Grace also continues to manage assets at the firm). While three of this target-date series' original team members remain, that's still a large amount of turnover for this fund family.

There's no concern about the committee members' investing experience; the group still averages over 23 years at the firm. Indeed, given the series' unconventional approach to asset allocation, there's a strong possibility that regular changes to the team will benefit the funds. That's because most target-date managers use some variation of modern portfolio theory to build portfolios of discrete asset classes, such as domestic large-cap stocks or high-yield bonds, and then fill those asset classes with strategies that conform to those categories. American uses a less-defined process, instead allocating money to four broad fund groups: growth, growth-and-income, equity-income/balanced, and bonds. The oversight committee members then rely on their own knowledge and personal experience with the funds (all of the committee members also manage some of the target-date series' underlying funds) to allocate assets to funds that fit those loose parameters.

Regular changes to the series' team members can help keep viewpoints fresh--perhaps a nontrivial feature given that the series' asset-allocation guidelines have so much room for interpretation. The newer members have already left their imprint on the firm's recently launched Portfolio Series funds. Those static-allocation funds have more streamlined lineups and use funds that are more distinct from each other. The target-date funds, in contrast, currently use almost every one of the firm's equity and taxable bond offerings.

Addition by Subtraction
Sometimes less is more, such as when a fund's top-heavy investment team sheds some of its members. Three managers have left JPMorgan Emerging Markets Equity JFAMX over the last three years, leaving Austin Forey firmly at the helm, and that's a good thing. The style of the most recently departed manager, small-cap specialist Greg Mattiko, didn't always mesh well with Forey's. Mattiko, who left in April 2012, focused on valuation over quality, while Forey prefers companies with sustainable competitive advantages and attractive returns on capital. Such companies tend to be larger-cap, another reason Mattiko's departure had less of an impact here. Despite (and partly because of) these changes, this fund has kept its Bronze rating and People pillar score of Positive.

As these examples show, fund personnel changes aren't necessarily negative, though they should prompt investors to dig deeper.

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Janet Yang is a fund analyst with Morningstar.
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