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Fund Spy

Who’s Helping the Fund Managers Manage?

Analyst staffs are important, but don’t stress about their numbers or traits.

Portfolio managers generally receive all the credit--or blame--for the performance of their funds. That’s understandable. Their names appear in the prospectus, they sign the shareholder letters, and in nearly all cases, they’re the ones making the final decisions on what to buy or sell, when to make the trade, and in what quantity.

But the reality is more nuanced. Except in rare cases, fund managers don’t work alone. Behind the scenes, their research analysts are banging away: researching securities, evaluating regulatory issues, monitoring and analyzing macroeconomic developments. They’re important but nearly invisible to most fund investors. However, managers or fund firms often will boast about the size, geographic spread, or other traits of their analyst teams. Without any context, it’s tough for most investors to evaluate these claims.

Below is a guide to making sense of fund-company claims. What do the analysts do? Should they specialize in one area or compare firms across many industries? What’s the best size for an analyst team--is bigger better? Does it matter if they sit next to the managers or are located closer to the companies they research?

It’s best to take a skeptical view when fund companies say that their way of doing things provides a clear-cut advantage. In all these areas, there is no single best approach.

Different Ways to Work

Some fund managers like to involve the analysts in nearly every aspect of their work: deciding whether a company is worth owning, choosing a target price, discussing position weights, and more. Analysts involved to this extent often end up as managers themselves. Other fund leaders prefer to separate the roles. They want their analysts’ attention focused on researching and evaluating companies and sectors. Worrying about whether a stock would fit in the fund’s portfolio and at what price would serve only as distractions. These managers think that decisions on pulling the trigger on buys and sells, position sizing, and balancing different risks in the portfolio are the purview and the responsibility of the manager alone.

Such managers don’t necessarily think less of their analysts’ ability. They’re convinced that researching companies and sectors, and the government regulations that might affect them, provide analysts with enough to digest and that adding more duties would be detrimental. Knowing how to construct a portfolio, some of these managers say, is a very different skill--as are the additional responsibilities of a portfolio manager, such as dealing with clients or writing commentaries.

Both approaches have their benefits and their limitations. A high degree of involvement may take time away from specific company research but better prepare one or more of the analysts to step up to a comanager position--taking some of the burden off the manager--and eventually take over as lead manager if the manager departs. Specialization allows analysts to dig deep and focus only on company prospects without being weighed down by other duties, but it can put the fund in a bind should the manager leave.

A Narrow Focus or Wide Lens?

Fund managers also vary in how they build their analyst teams. Some want their analysts to be generalists, able to evaluate companies in just about any field. They think that approach provides a broader context for judgment than simply comparing companies against others in the same industry. Also, some managers believe that analysts who specialize will inevitably promote stocks in their sector even if none are truly compelling options. That could occur because it’s the only sector the analyst knows, or the analyst is protecting his or her job. (If the fund hasn’t owned an energy stock in several years, who needs the energy analyst?)

Many other managers take the opposite view. They prefer to hire specialists who focus mainly, or solely, on just one sector such as technology or banking. They believe such specialization allows researchers to develop a level of expertise in their field that generalists could never match.

Sometimes the area in question is narrowed further, such as biotech or software rather than healthcare or technology. The biotech analysts at some firms even have advanced degrees in medical or scientific fields, and perhaps a prior stint in those fields before they turned to investing. International funds often have analysts specializing in specific regions who may have lived there and have language expertise.

Both approaches can succeed or fall short. Neither should be considered prerequisites for outperformance, because so many other factors come into play, as discussed more fully below.

From the Few to the Many

Then there’s the question of size. Fund firms with large analyst teams don’t hesitate to advertise that fact. As a result, investors might be surprised to learn that some boutique firms carry just a few analysts. Sound Shore (SSHFX), a U.S. large-cap stock fund with a solid long-term record, has had three or four analysts to assist its three managers. Rezo Kanovich, manager of the excellent Artisan International Small-Mid (ARTJX), has only three analysts, one of whom was hired just recently. AMG Yacktman (YACKX) has built an enviable long-term record with a minimal staff; for years its two managers had just two analysts. (One was recently promoted to comanager and replaced by a new, junior analyst.)

At the other extreme are the giants like Fidelity, which according to a recent count, had 110 stock analysts stationed in Boston, London, and Tokyo, along with many additional analysts who focus on sectors or countries. (Still others focus on fixed-income or other asset classes.) T. Rowe Price, Putnam, and Dodge & Cox also have extensive teams, as do Franklin Templeton and Capital Group (American Funds). Portfolio managers in these bulked-up organizations typically can see hundreds or thousands of research notes amassed by the research teams, contact any individual member for a direct conversation, or ask for further investigation into a specific company or topic.

Of course, many firms lie somewhere between these two endpoints; analyst staffs in the teens, twenties, or thirties are common. Sometimes portfolio managers with a particular expertise will serve as the analyst for that sector, so the number of “analysts” on a staff can vary depending on whether the firm includes those managers in the count.

Is Bigger Better?

So, what is the optimal size for a research team? One might assume that having scores of analysts provides a clear advantage. But over decades of covering mutual funds, Morningstar Manager Research analysts haven’t found that to be the case. That said, neither is a small, tightly focused group inherently superior. Other factors play key roles in determining fund success.

One variable is the number of strategies an analyst staff must support. A team responsible to a large array of managers running funds of many different styles--like Fidelity’s group--would almost certainly need to be larger than a team supporting just one strategy. Stability also matters more than size. A team that’s been stable for many years tends to instill more confidence than one suffering personnel turnover year after year. Another important consideration is how well or poorly the managers and analysts interact and communicate with each other, and the talent level of the analysts in identifying promising targets and warning against companies with weak prospects.

Quality and Stability Outweigh Numbers

The last point is critical. More important than size is the quality of the analysts and the stability of the team. Goldman Sachs’ value and growth teams that focused on U.S. stocks (before they merged into one group in early 2018) boasted more analysts than Sound Shore, AMG Yacktman, and Kanovich’s fund added together; but constant personnel turnover--and in some cases, poor stock choices--hobbled their funds’ performance. Simply hiring more analysts wouldn’t have improved anything.

In fact, after the merger of the two teams, the firm had significantly fewer analysts researching U.S. stocks. Although the claim must be taken with a grain of salt, they said they kept the best analysts from each team and let the others leave or find other positions in the organization. Although it’s not a long period, if anything performance seems to have improved since the move to a smaller, consolidated group.

By contrast, the analysts from Sound Shore, Yacktman, and Kanovich’s Artisan International Small-Mid have worked with the managers for many years, with departures rare.

Boots on the Ground, or Shoes in the Office?

Fund firms--especially those featuring international funds--also boast about the geographic reach of their analyst staffs. As with large teams, at first glance this might appear an obvious benefit. Sometimes it is: We’ve spoken with managers who can cite cases where their locally based analyst alerted them to information unmentioned in company financial reports, discussions with executives, or news stories that served the managers well in making portfolio decisions. Some funds with globally dispersed teams have thrived.

But a global footprint is not a necessity. Until the disruptions caused by the coronavirus pandemic, Dodge & Cox’s large pool of managers and analysts all worked in the same office in San Francisco. With this all-in-one-place approach, the firm established a strong reputation for its value-focused lineup, which includes Dodge & Cox International Stock (DODFX) and Dodge & Cox Global Stock (DODWX). Only in April 2021 did it establish an indirect subsidiary in Shanghai to provide supplemental China-focused research.

Similarly, the small staffs of Invesco Developing Markets and Artisan International Small-Mid also reside in the same office with the manager, and both strategies have amassed outstanding records. Nearly all of Harding Loevner’s bigger investment staff, which guides a suite of impressive international funds, is based in New Jersey.

Conversely, Longleaf Partners had investment personnel stationed in Japan and Europe, but that didn’t prevent Longleaf Partners International (LLINX) from getting waylaid by a fraud scandal in Japan’s Olympus in 2011 and being hurt badly by the crash of Allied Irish Banks and other European construction-related stocks during the 2008 global financial crisis.

Conclusion

It would be counterproductive, therefore, to invest in a fund based on the size, working arrangements, or location of its analyst staff. An exception might be stability: It’s reasonable to be wary of frequent analyst turnover or if a firm often changes the structure or responsibilities of its investment professionals.

This information isn’t necessarily easy to find out. In order to get detailed information on the staff supporting the manager, beyond the impressive but limited nuggets shared in fund advertisements and PowerPoint presentations, one must be in communication with the fund company. That’s because fund companies aren’t required to publicly disclose analyst arrivals and departures or team structures, as they must for named portfolio managers. But many financial advisors and fund researchers--like those of us at Morningstar--who communicate regularly with fund personnel do have the opportunity to acquire this information. (With rare exceptions.)

Even when such information is available, though, it shouldn’t be overemphasized. As interesting as the makeup of a fund’s research team can be, it usually offers little guidance to a fund’s appeal as an investment. It’s just one data point among many when considering whether to invest in a fund.

Gregg Wolper has a position in the following securities mentioned above: DODFX. Find out about Morningstar’s editorial policies.