What to Look for in a Fund Manager

One of the great advantages of buying a mutual fund is that a professional, or a group of professionals, will pick stocks for you. Because you are sharing the costs of the mutual fund manager with thousands or millions of other shareholders, the fund manager comes at a really cheap price. Find out what you should look for in a fund manager.

Fund Manager for Hire

Finding the right mutual fund manager is kind of like finding the right employee. You should study their experience and their accomplishments, and you should always do a background check before you hire them.

As with job applicants, fund managers come in all varieties, but unlike a job applicant, a fund manager can be more than one person. Mutual funds usually use either a fund team (more than one decision maker), a fund manager (who might work with a team, but calls the shots), or the funds assets are split up between a group of fund managers who work independent of each other.

Experience

Journalists always talk about a fund manager’s tenure. “How long has he been running the fund?” they might ask. “Don’t buy a fund with a fund manager who has spent less than five years running the mutual fund” they might advise. Despite the focus on fund manage tenure there’s no clear evidence that tenure matters. Wonderful managers have left a fund only to be replaced by even better managers. Decorated managers have also stayed with their fund and ended up on the worst performing lists for years. The Journal of Financial Planning found no relationship between manager tenure and performance in this study. Other studies have said differently, but it is safe to say that tenure may not be as important as often preached.

Needless to say, a fund manager with experience is preferred. How long has this person been in the fund business? Does this person have a strong academic background? Does this person carry any investment designations. Do you feel your fund manager is wise? Just because your fund manager might be battle-tested, it doesn’t mean they are battle-wise – in fact, a fund manager that has been burned in the past by the market might be too hesitant to act when the time is right.

If you’re looking at a new fund or a fund that just changed managers, study the fund manager’s bio. Has he/she been at it for a while? If they ran a different fund before heading the current one, take a look at their track record versus their peers in the old fund. Some fund companies, like Fidelity and American are known for their star benchwarmers just waiting to head a fund.

Accomplishments

How did your fund manager perform during both bull and bear markets? How does your fund manager’s track record compare to his peers? Does the fund manager have a positive or negative alpha (you want positive as it means they are adding something to performance).

Like the music industry, we don’t want just a one-hit wonder. If this fund manager topped the lists one year, it doesn’t mean it will happen again next year. Be cautious of the fund managers that are talking heads and don’t underestimate the silent or not as well spoken fund managers. Luck is a big part of the success of many fund managers – don’t mistake luck for skill. Often the fund’s category is more responsible for performance results than the fund manager’s stock selection. That’s why it is important to compare fund performance to category peers.

True Style

Is your fund manager passionate about their investing strategy? Is your fund manager true to the style of the fund? You don’t want a value fund buying growth stocks or a large cap fund buying small stocks. Asset allocation is important to building a fund portfolio that is in-line with your risk tolerance and financial situation. The last thing you want is the fund manager to violate what the fund states it is all about.

Another thing to look out for is a closet indexer. We always hear that 80% of funds are beat by the S&P 500 each year, so it only makes sense that some sneaky fund managers might mimic the S&P 500 without telling us. If the fund claims it isn’t an index fund, but the r-squared measure for the fund is 97 or higher, you probably have a closet indexer on your hands. If that is the case, you might as well use an index fund instead.

What’s at Stake?

In a wonderful move in late 2004, the SEC ruled that fund managers must disclose their ownership in the fund they are running. You want a fund manager that has a financial interest in how he does and a strong ownership in the fund shows that the fund manager believes in him or herself.

This article continues with Fund Manager Background Checks.