The Career Paths of Mutual Fund Managers: The Role of Merit

This study provides evidence that merit—specifically, performance relative to peers measured on a style-adjusted basis—plays a significant role in the length of a mutual fund manager’s career. Managers who underperform their peers are more likely to lose their jobs. However, surviving managers of any tenure—even those who manage their funds for 10 or more years—generally do not outperform the market or their style benchmarks and do not display consistently superior performance. In this study, we examined the career performance of solo managers of 2,846 actively managed mutual funds over 1996–2008 using data from Morningstar. Turnover among this group of managers was high, with nearly 19% lasting no more than one year and more than 75% lasting no more than five years. We measured relative monthly performance on a style-adjusted basis by computing each manager’s total monthly return less the average return to all other funds of the same Morningstar style. We also tested the results by expressing this relative performance in deciles and repeated the tests using performance measured by both Carhart and Jensen alphas. In addition, we controlled for managers whose funds became team managed or who changed funds, possibly owing to a promotion. The results provide evidence of the role of merit in the careers of managers of actively managed funds. Consistent with prior studies, we found that relative performance is an important determinant of career success as a mutual fund manager. We showed that managers who underperform on a style-adjusted basis are at greater risk of losing their jobs. However, the evidence on the role of superior performance is less strong. Surviving managers of all tenures, even those who lasted 10 or more years, outperformed those with shorter tenures, but we also showed that they did not consistently outperform the market on a risk-adjusted basis or their style benchmark. Data on style-adjusted monthly returns show that solo managers with 10 or more years of tenure outperformed about as often as they underperformed. When performance is calculated using Carhart or Jensen alphas, even solo managers with tenure of more than 10 years show no ability to beat the market on a risk-adjusted basis. The key to a long career in the mutual fund industry seems to be related more to avoiding underperformance than to achieving superior performance. The lack of significantly better performance over time by long-tenure managers suggests that longevity is related to the avoidance of underperformance. Additional factors may be at work in impairing the performance of these managers. For example, researchers have found evidence that some underperforming managers at smaller funds are able to retain their positions despite their performance. Additionally, other research has shown that a significant proportion of the best mutual fund managers earned their reputations with high rates of return early in their careers and had performance that was significantly worse later on. Whether this early performance was due to luck or early superior skills that atrophied later is subject to conjecture and further research. Many other opportunities for future research exist. For example, there are many potential reasons for a manager losing sole control of a fund, from board-related or professional considerations to personal ones. Because employers seldom announce that an employee’s demotion or departure is related to performance, it is difficult to isolate those cases where a change occurred for reasons not related to performance. We partially controlled and tested for this effect by isolating solo managers who left one fund and became solo manager of another fund. However, the robustness of our results suggests that better isolation of nonperformance issues would strengthen rather than significantly weaken our findings.