Morningstar Mythbusters Investigates the Fund Manager of the Year Jinx

One year ago my colleague John Rekenthaler wrote an article investigating whether Morningstar Fund Manager of the Year award winners outperform their peers in the 10 years after they receive their awards. (For more-recent winners, he used the longest time period available.) He found that, on average, domestic-stock winners do beat out their category peers on a risk-adjusted basis, albeit on a modest margin. Fixed-income winners have a better peer-beating record, and international-stock winners walloped the competition by a wide margin on a risk-adjusted basis.

While the awards are intended to reward past performance and not predict future returns, it's nice to know that funds of winners do tend to perform better than those run by nonwinners on a risk-adjusted basis in the long term. But what about the short term or intermediate term? How long does it take for the just-decorated cream of the fund manager crop to rise to the top of their categories? While people joke that the award is jinxed, we find that managers have done well after the award--but the time period measured matters. Winners' funds frequently outperform on a risk-adjusted basis five or 10 years after the manager receives the award, though there is some dispersion in the one- and three-year period risk-adjusted returns.

To answer this question, I looked at fund performance in the one-, three-, five-, and 10-year periods after the win. For instance, Jerry Palmieri won the award in 1987, so I looked at fund performance for calendar-year 1988, the three-year period from Jan. 1, 1988, through year-end 1990, the five-year period from Jan. 1, 1988, through year-end 1992, and the 10-year period from Jan. 1, 1988, through year-end 2007. For each time period, I compared the fund's risk-adjusted performance with its category average risk-adjusted return. Like John's previous article, I sorted the results into five buckets. The fund either beat the category average Morningstar Risk-Adjusted Return by more than 400 basis points, beat the category average MRAR by 100-400 basis points, finished within 100 basis points of the category average MRAR, underperformed by 100-400 basis points, or underperformed by more than 400 basis points. These buckets are not particularly scientifically designed but are intended to serve as a reasonable proxy for risk-adjusted returns that investors would consider excellent, good, acceptable, slightly disappointing, and very bad.

Once I sorted the one-, three-, five-, and 10-year performance of all Fund Manager of the Year award winners, I tallied up how many funds were in each bucket for each time period. The results are below. (Note that the sample size is smallest for the 10-year period and largest for the one-year period.)

  - source: Morningstar Analysts

  - source: Morningstar Analysts

  - source: Morningstar Analysts

  - source: Morningstar Analysts

In the one year immediately following the award, risk-adjusted returns relative to the category are diffuse, though more winners outperform than underperform. There are more extreme cases that out- or underperform the category average by more than 400 basis points than cases that hew closer to the average, resulting in a barbell distribution of observations. Such a trend brings to mind notable fund managers who had a down year after receiving the Fund Manager of the Year award, like Michael Hasenstab of  Templeton Global Bond (TPINX). However, others had strong years, such as 2010 winners Bob Goldfarb and David Poppe of  Sequoia (SEQUX) and 2003 winners Howard Schow, Theo Kolokotrones, and Joel Fried of  Vanguard PRIMECAP (VPMCX).

​At three years after receiving the award, winning managers' funds begin to outperform more frequently. Out of the 55 winners' funds with a three-year record, 33 outperform their category average by 100 basis points or more on a risk-adjusted basis, while only 17 underperform by 100 basis points or more. However, extreme values are still more common here. Only five funds land within 100 basis points of their category average on a risk-adjusted basis, compared with 11 that outperformed by more than 400 basis points and seven that underperformed by more than 400 basis points.

At five years, the data smooths out considerably and dramatically more winners perform better than their category peers--suggesting that the one-year results are due to the noisiness of any short time period rather than a signal of a downturn. The extreme values shrink and the data takes on a recognizable bell-curve shape, albeit with a conspicuous positive trend. Out of the 49 award winners with five years of subsequent performance history, only eight underperformed their category average on a risk-adjusted basis by more than 100 basis points. In contrast, eight outperformed the category average by more than 400 basis points and a whopping 23 beat the category by 100-400 basis points on a risk-adjusted basis. The 10-year results display a similar trend. Out of 33 winning funds with a subsequent 10-year record, five underperformed by more than 100 basis points and one merged or liquidated before the period was up. Five funds beat out the category average by more than 400 basis points, while 13 beat the category by 100-400 basis points. Not bad! Consider winners in the 1990s such as Bill Gross, Bob Rodriguez, and Dan Fuss, who went on to produce strong results for more than 10 years after winning.

Differences in shorter-term results by asset class can shed a little light on the one-year and three-year noise in risk-adjusted returns. Good old mean reversion is certainly a possibility, but the method of selecting winners can also provide some insight. Fund Manager of the Year winners are selected on a number of factors; high among them is long-term past performance, but fund performance in the year of nomination also counts. Macroeconomic trends such as a rise in commodity prices or a global tightening of credit spreads on bonds can dramatically boost a very active fund's performance one year but just as easily drive it into the ground in the next year. This can certainly help explain the barbell distributions of the one-year results for Domestic-Stock and International-Stock winners. The many stock funds that did very well one year after the manager won the award may have still enjoyed a market that favored their particular strategy. Meanwhile, the stock funds that drastically underperformed one year after the manager won the award could have suffered headwinds from a previously favorable market that took a punishing turn against their particular investment styles. The one-year results for Fixed-Income winners don't follow this trend and instead just show a tendency to outperform by 100-400 basis points in the year after receiving the award. This could be because the dispersion of returns for fixed-income funds is narrower than equity funds (resulting in fewer extreme values). In all cases, however, winners tend to beat the average rather than trail it over time. Whether the short-term noise is from mean reversion or a highly active strategy hitting a tough spot in the market cycle, this much is clear: What may look like a precipitous fall from grace is likely just a bump in the road, and patience frequently pays off handsomely.

  - source: Morningstar Analysts

  - source: Morningstar Analysts

  - source: Morningstar Analysts

As for the Manager of the Year Jinx, the evidence suggests that there is no such thing. While there are certainly prominent examples of managers whose funds tanked a few years after receiving the award, there are even more cases of decorated managers who went on to make lots of money for many fund investors in the same amount of time. In fact, for longer-term periods, the Fund Manager of the Year designation acts like a reverse jinx; funds of winners perform dramatically better than their category peers on a risk-adjusted basis. How's that for a myth busted?

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