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More Cooks Improve the Broth

The case for management teams.

John Rekenthaler, 03/20/2014

Three Is Company
Team portfolio management has become quite the fashion. Whereas 67% of U.S. stock funds were run by a single manager in 1992, the figure today is less than 30%. Conversely, whereas large teams were once almost unheard of, a full one fourth of such funds currently are run by four or more managers. 

Those numbers come from "To Group or Not to Group? Evidence from Mutual Funds,"from Saurin Patel of University of Western Ontario and Sergei Sarkissian of McGill University. Using Morningstar data, which they cite as the reason for their breakthrough discovery (apparently CRSP, the standard academic source for fund information, has spotty manager data), the authors find evidence that U.S. stock funds with multiple managers outperform those with a single manager. 

Surprisingly, the benefit comes from more returns rather than less risk. One would think that having more managers brings more diversification, which in turn brings lower volatility along with potentially lower returns. However, on average, funds run by two- and three-manager teams have slightly higher standard deviations than do those run by a sole manager. Those with a single manager have the lowest returns, with the highest numbers coming from funds with three managers and five or more managers. 

These are small effects. The authors estimate the four-factor alpha of three-manager funds to be 0.43% annually, or 43 basis points, above those of funds run by a single manager. The victory margin for funds headed by five managers or more is 47 basis points. Because there are a great many funds, however, those modest amounts are statistically significant at the 5% level. 

Perversely, the more managers assigned to a fund, the less that the fund costs. For funds that have five or more managers, the reason is simple; those funds are much larger than other funds, so they benefit from economies of scale. (As the authors present asset size as an average rather than as a median, I suspect that this effect is driven by several massive American Funds.) Funds with two to four managers, though, are of a similar size and age, yet are modestly cheaper than single-fund managers. 

In addition to finding in favor of management teams, which is new to the literature, the professors confirm several other effects that have previously been documented. All things being equal, funds fare better if they: 

1)      Have a smaller asset base,
2)      Are younger,
3)      Come from a larger fund family,
4)      Have a lower expense ratio (duh),
5)      Have superior past performance,
6)      Are run by managers who have higher SAT scores.

The latter isn't quite how it reads. I wondered how the authors found managers' SAT scores, which most assuredly are not in Morningstar's database. They didn't. They instead know where managers received their undergraduate degrees, and they plugged in the typical SAT range found at those colleges as the estimate for each manager's score. Yes, that's a stretch. However, the result is consistent with other studies that have found stronger performance for funds run by managers who attended more prestigious colleges, as well as for managers who have MBA degrees. 

is vice president of research for Morningstar.

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