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Bill Ding, SUNY at Albany Russ Wermers, University of Maryland (Presenting) November 8, 2012

Mutual Fund Performance and Governance Structure: The Role of Portfolio Managers and Boards of Directors. Bill Ding, SUNY at Albany Russ Wermers, University of Maryland (Presenting) November 8, 2012. My New Textbook (Available soon via amazon.com). Relevance of Fund Managers.

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Bill Ding, SUNY at Albany Russ Wermers, University of Maryland (Presenting) November 8, 2012

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  1. Mutual Fund Performance and Governance Structure: The Role of Portfolio Managers and Boards of Directors Bill Ding, SUNY at Albany Russ Wermers, University of Maryland (Presenting) November 8, 2012

  2. My New Textbook(Available soon via amazon.com) Mutual Fund Managers and Directors

  3. Relevance of Fund Managers • The mutual fund performance literature generally ignores the role of fund managers and fund governance • (e.g., Jensen (1968), Grinblatt and Titman (1989), Wermers (2000), Carhart (1997), and Chen, Hong, Huang, and Kubik (2005)) • Stockpicking talents may reside at the managerial level, rather than exclusively at the fund level • High compensation [median base plus bonuses (2004) is $340K—higher than median hedge fund manager compensation] • Skill development • Relationship development (pre-Regulation FD and post-Regulation FD) Mutual Fund Managers and Directors

  4. The Public Perception of Managers • Mutual fund “star” managers are profiled regularly by the Wall Street Journal, New York Times, Bloomberg, and other media sources • Peter Lynch, formerly of Fidelity Magellan has reached almost legendary status • Bill Miller, of the Legg-Mason Value Trust Fund, has beaten the S&P 500 for 15 years in a row—prior to 2007—and became media “star” Mutual Fund Managers and Directors

  5. Recent SEC Adoption of Enhanced Portfolio Manager Information • On August 18th, 2004, the SEC adopted “Disclosure Regarding Portfolio Managers of Registered Investment Companies,” which requires disclosure of: • Manager identity, including “teams” (in fund prospectus) • Name, title, experience with fund, career experience • Other accounts managed by each manager (in SAI) • Compensation method for each manager (in SAI) • Ownership by fund manager of fund shares (in SAI) Mutual Fund Managers and Directors

  6. Past Research on Mutual Fund Managers • Manager characteristics and fund risk-taking and performance: Chevalier and Ellison (1997 JPE, 1999 QJE, 1999 JF) • Manager contribution vs. fund contribution to performance (Baks (2004)) • Manager changes: Khorana (1996, 2001) Mutual Fund Managers and Directors

  7. If Fund Managers Matter, then the Following Issues Become Important • Is scarce fund manager talent allocated efficiently in the mutual fund industry? • In an efficient fund manager labor market, • Underperforming fund managers get demoted or fired (and/or suffer outflows) • Outperforming fund managers get promoted (and/or attract inflows) • Therefore, more experienced managers (who have also exhibited better past talents) manage bigger funds Mutual Fund Managers and Directors

  8. Relevance of Fund Directors • In September 2003, New York Attorney General Eliott Spitzer announced a widespread investigation of mutual funds • As of September 2004, 25 fund families were apparently involved in the market timing and late trading scandals • Settlements reached $2 billion • The widespread nature of mutual fund scandals seem to question the effectiveness of fund governance • The board of directors may be an important internal governance force to monitor managers Mutual Fund Managers and Directors

  9. New SEC Rules on Fund Governance (originally effective September 7, 2004; currently stayed by the U.S. Court of Appeals) • At least 75% of the directors must be independent • Over 80% currently conform to this requirement • The board's chairman must be independent • More hotly contested by the industry • The board measures (at least annually) the performance of the board and its committees • The independent directors meet at least quarterly in a session with no interested directors present • Independent directors are authorized to hire independent employees and to retain advisers and experts necessary to carry out their duties Mutual Fund Managers and Directors

  10. Role of Boards of Directors in Fund Performance • Our Conjecture: When the board is more effective, a fund performs better and the advisor is more likely to discipline managers for underperformance • Directors negotiate fund fee contracts with fund advisors • (Indirectly) help to select (and fire) fund managers, as well as to incentivize managers • Can argue for increased support for underperforming manager (e.g., more analysts, co-managers) • Prevent family cross-subsidization (a la Massa paper) at the expense of their fund • If so, what are the characteristics of effective boards? Mutual Fund Managers and Directors

  11. Contributions of Our Study • We provide insight into issues of fund governance: • Do independent directors improve the efficiency of manager labor markets? • Do they improve fund performance through monitoring of fund manager and management company behavior? Mutual Fund Managers and Directors

  12. Mutual Fund Manager Data • Extensive panel dataset of fund managers, 1985 to 2002, compiled from: • Morningstar (including M-S Librarian) • Thomson/Wiesenberger • CRSP (1992-2002) • Various mutual fund publications during 1984-91 • Mutual Fund Directory of Investment Dealers’ Digest • Mutual Fund Profiles of S&P/Lipper (1987-91) • Handbook for No-Load Fund Investors (1984-91) • Mutual Fund Sourcebook of Morningstar (1984-91) • Archived fund filings from SEC’s Public Reference Room Mutual Fund Managers and Directors

  13. Summary Statistics on Fundsand Fund Managers • Manager data is matched with stockholdings data from CDA/Spectrum and net returns/characteristics data from CRSP (see Wermers (2000) for description) • Limited to funds having an investment objective of AG, G, GI, I (actively managed, diversified domestic-equity funds) Mutual Fund Managers and Directors

  14. Peter Lynch’s Tenure Mutual Fund Managers and Directors

  15. Counts of Funds/(Percentage With Missing Managers) (Table I) Mutual Fund Managers and Directors

  16. Median Fund Manager Characteristics(Table II, Panel A) Mutual Fund Managers and Directors

  17. Reasons for Manager Replacement (Not in Paper) Mutual Fund Managers and Directors

  18. Average Fund Size ($millions), Segregated by Fund Manager Characteristics(Table II, Panel B) Mutual Fund Managers and Directors

  19. Following-Year CS Portfolio Performance,Largest 20% of Funds (Table III, Panel A) Mutual Fund Managers and Directors

  20. Following-Year CS Portfolio Performance,Smallest 20% of Funds (Table III, Panel C) Mutual Fund Managers and Directors

  21. Dependent Variable: Fund Performance (Year t+1) (Table IV) Mutual Fund Managers and Directors

  22. Director Data • We collect director data for 1995, 1999, and 2002 (Lipper provided 2002) • Total number of directors for each fund • Number of outside directors • Whether board chair is insider or independent Mutual Fund Managers and Directors

  23. Harris and Raviv (2005)Theory of Board Structures • For boards that are majority outsider (by regulation), additional outsiders only play an additional information-gathering role • Too few outsiders means incentive for more information collection • Too many outsiders means each outsider has increasing free-rider problem • Optimum number of outsiders: benefits of collecting incremental information equals costs (for each outside director) Mutual Fund Managers and Directors

  24. Summary Statistics on Board Characteristics(Table VI) Mutual Fund Managers and Directors

  25. Correlations Between Board Characteristics (1995, 1999, and 2002) Mutual Fund Managers and Directors

  26. Logit Regressions of Manager Replacement(Pooled Years 1995, 1999, and 2002, Table VII) Mutual Fund Managers and Directors

  27. Regressions of Fund Performance on Governance Variables (Table VIII) Mutual Fund Managers and Directors

  28. Summary of Director Results • Underperforming managers are more likely to be replaced with boards having more independent directors • When manager has at least 10 years experience • Flows and management company only effective for replacing managers with less than 10 years experience • Funds with larger numbers of independent directors tend to perform better • Over 75% tends to decrease performance • Insiders better monitor “hidden actions” • Only weak evidence that inside chair impacts performance Mutual Fund Managers and Directors

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