224 JOURNAL OF ECONOMICS AND FINANCE • Volume 27 • Number 2 • Summer 2003Mutual Fund Managers:Does Longevity Imply Expertise?Bruce A. Costa and Gary E. Porter* Abstract We analyze the performance of 1,042 mutual funds from 1986 to 1995 to measure the relationship between manager tenure and performance. Funds whose managers’ have at least ten years tenure do not generate significantly higher excess returns than funds with less experienced managers. The excess returns of the best managers are not greater than those of their less experienced colleagues. Regardless of tenure, managers producing positive risk adjusted returns for three years are not likely to repeat their performance in subsequent periods. Our results provide further evidence that tenure should not be a factor in selecting mutual funds. (JEL G20) Introduction While academics debate the ability of actively managed mutual funds to exhibit consistentsuperior performance and attempt to identify the characteristics that evidence such ability, mutualfund companies continue to tout the experience of their managers as a key factor in suchperformance. For example, a recent advertisement in Smart Money magazine for the FederatedKaufman Fund proclaims “EXPERIENCE COUNTS,” citing their 11 consecutive calendar yearsof positive returns. Additionally, Morningstar, Inc., a provider of mutual fund data, suggests thatthe manager’s tenure at a fund and reputation are valuable considerations in fund investing.1 Identifying any factors linked to consistent superior performance is vital to investors seekingto maximize investment returns. Among the factors that researchers have linked to superiorperformance are time frame and fund type. Goetzmann and Ibbotson (1994) demonstrate thatmanagers who perform better than their peers in one two-year period tend to perform better thantheir peers in the subsequent two-year period. Volkman and Wohar (1996) show persistent * Bruce A. Costa, School of Business Administration, University of Montana, Missoula, MT 59812-6808,firstname.lastname@example.org; Gary E. Porter, Boler School of Business, John Carroll University, University Heights, OH44118-4581, email@example.com. The authors wish to thank Eric J. Higgins, Keith Jakob, Jonathan Karpoff, Ajay Khorana,David Peterson, and Pamela Peterson for their comments. 1 Morningstar’s website, www.morningstar.com, provides the following explanation for under manager name in itsdata definitions section: “We also note the year in which the manager began running the fund. This information is usefulfor determining how much of a funds performance is attributable to its current management. Investors often wonderwhether they should redeem their shares in a fund when it changes managers. This question usually arises when a managerwith a great reputation leaves a fund.”
JOURNAL OF ECONOMICS AND FINANCE • Volume 27 • Number 2 • Summer 2003 225superior excess returns over a three-year investment period are directly related to persistence inprior returns, and Grinblatt and Titman (1993) show that aggressive growth funds producepersistent abnormal returns during their test period. Nearly all studies report that inferior returnstend to show some degree of persistence. In their examination of mutual fund performance, however, Elton, Gruber, and Blake (1996a)and Carhart (1997) show that common factors in stock returns almost completely explain thepersistence in equity mutual fund performance. Carhart claims that studies indicating performancepersistence are mostly driven by a one-year momentum, “hot hands” effect, while the studies byMalkiel (1995) and Elton, Gruber, and Blake (1996b) suggest that strong evidence of continuedsuperior performance is a consequence of fund survivorship, not necessarily managementexpertise. Gruber (1996) provides evidence that sophisticated investors can identify superiormanagement and are able to capture positive risk-adjusted excess returns because managementexpertise is not priced. Moreover, these superior managers tend to generate persistent excessreturns, allowing investors to identify them and benefit from their future performance. Similarly,Wermers (2000) concludes that active managers possess the expertise to add value because, onaverage, they hold stocks that outperform the CRSP index, though he does not addressperformance persistence. The contribution of this paper is to test the notion that management tenure can be a proxy forexpertise, and hence a factor in explaining both magnitude and persistence in the performance ofactively managed funds. We test our hypothesis by controlling for the tenure of management inour sample.2 We investigate the link between tenure and performance during the period 1986through 1995. This period produced a variety of market conditions, including the crash of 1987, arecession and bear market in 1991, followed by a bull market that extended through 1995.Supporters of active management, including the funds themselves, argue that active managementis especially valuable during down markets. Our tests compare the excess, risk-adjusted returns offunds managed by individuals with extensive experience at a fund, defined as having at least 10years tenure, to the excess returns from a control sample of funds managed by individuals withless tenure. To measure risk-adjusted excess fund returns, we apply a three-factor model based onthe mutual fund performance methodology of Gruber (1996), which, in turn, is consistent with thecomprehensive analysis of common stock returns by Fama and French (1993). Our results indicate that excess returns are not a function of lengthy tenure at a specific fund.The results show (1) during the period 1986 through 1995 our sample funds generate a positive,significant, risk-adjusted monthly excess return (alpha) of 0.16 percent (1.89 percent, compoundedannually), but the performance of a sample of the 112 funds managed by individuals with at least10 years tenure is not significantly different from the performance of the control sample consistingof 930 funds managed by individuals with less than 10 years tenure; (2) significant, positivealphas are the product of a few crucial years common to all funds; and (3) management’s ability toproduce positive alphas in each year of a three-year base period is not indicative of comparableperformance in subsequent periods, regardless of the tenure of the manager. In short, funds withexperienced managers are unlikely, on average, to produce risk-adjusted excess returns that aregreater, or more persistent, than funds with less experienced management. The evidence suggests 2 A small number of studies have addressed the relationship between managers and fund returns. Porter and Trifts(1998) provide evidence that managers with lengthy tenure at a specific fund are unable to demonstrate consistent, superiorperformance relative to their peers. Their study does not explicitly control for the risk factors cited by Fama and French,however. Khorana (1996) examines the relationship between management replacement and prior performance. His studyalso does not adjust returns to reflect the Fama and French factors.
226 JOURNAL OF ECONOMICS AND FINANCE • Volume 27 • Number 2 • Summer 2003that, in general, claims that tenure implies expertise in generating superior returns should beviewed with skepticism. Our results suggest that the returns are not biased by an individual manager’s expertise overan extended period at a specific fund. The results of the study are consistent with a number ofmutual fund performance studies. Our evidence is consistent with Porter and Trifts (1998). Usingpercentile rankings to measure performance, they demonstrate funds with long-term associationswith managers do not outperform their peers in similar investment objectives. Our work extendstheirs by using excess returns, adjusted for the common factors associated with stock returns, toidentify superior managers and by comparing the performance of managers with at least 10 yearsexperience against all others in each year of the 10-year test period. Our results are also consistentwith studies by Fama and French (1993) and Elton, Gruber, and Blake (1996a) showing thatreturns of these actively managed mutual funds are largely explained by common factors. Thesefactors are the risk premium on the market index, the difference in return between a small- andlarge-capitalization stock portfolio, and the difference in return between a growth and a valuestock portfolio. The results are also consistent with those of Brown and Goetzmann (1995), whofind that relative performance depends on the time period observed. The next secion presents our methodology, the third section describes our data, and the fourthcontains our results. The fifth summarizes our conclusions. Methodology The objective of our study is to determine whether investors, upon choosing a fund style, aremore likely to be rewarded with superior, risk-adjusted returns if they seek out managers withlongevity at a fund, and whether these managers are more likely to generate superior returns overextended periods than their less experienced counterparts. To accomplish this objective our testmust measure the performance of two subsets of managers in each of the 10 sample years: thosewith at least 10 years tenure at a fund and those with less. Mutual fund performance studies use a variety of benchmarks. According to Elton, Gruber,Das, and Hlavka (1993), whether the benchmarks are mutual funds with similar investmentobjectives or popular indexes such as the S&P 500 for large growth stocks or the Russell 2000 forsmall growth stocks, test results tend to overestimate actual performance results. Following Famaand French (1993), who show that book-to-market ratio and size are factors in explaining stockreturns, Elton, Gruber, Das, and Hlavka (1993) and Gruber (1996) report that the failure to includesuch variables can bias mutual fund performance. To avoid the problems associated with using a single benchmark or index, we use themethodology of Fama and French (1993), who employ a multi-factor model that accounts for theimpact of several risk premiums on equity returns. The methodology uses the risk premium on themarket index as an explanatory variable to capture the systematic impact of the market on fundreturns.3 The methodology also uses the spread between the return on a small- and a large-capitalization index and the spread between a growth and a value stock index to account for theinfluence of management style on fund returns. The three-factor model4 we employ is: 3 We use the CRSP value-weighted index instead of the S&P 500 Index as a proxy for the market return because theCRSP index includes dividends paid by the firms while the S&P 500 does not. This provides a more accurate measure ofreturn. 4 Our tests do not include a bond index because our study excludes bond funds. Fama and French (1993) noted thatbond related factors are only important in capturing the returns for bond funds and add no explanatory power to the modelwhen measuring the performance of equity.
JOURNAL OF ECONOMICS AND FINANCE • Volume 27 • Number 2 • Summer 2003 227 Ri, t - Rf, t = α i + βM, i (Rm, t - Rf, t) + β S, i (Rs, t - Rl, t) + β G, i (Rg, t - Rv, t) + ε i, t (1)where Ri, t - Rf, t = excess return. The return on fund i in month t minus the return on a 90-day T-bill for month t. Rm, t - Rf, t = the return on the value-weighted CRSP index for month t minus the T-bill return in month t. Rs, t - Rl, t = the difference in the return between the small-capitalization index and the large- capitalization index for month t. Rg, t - Rv, t = the difference in the return between the high growth index and the value index for month t. αi = the monthly risk-adjusted excess return for fund i. The appendix provides details for the construction of the indexes. Alpha (αi), the interceptterm, is the mean, monthly risk-adjusted excess return according to Jensen (1968). Alpha shouldnot be different from zero for any test period if the Efficient Market Hypothesis (EMH) holds.Alpha will be positive “...if the portfolio manager has an ability to forecast security prices. Indeed,it represents the average incremental rate of return on the portfolio per unit time which is duesolely to the manager’s ability to forecast security prices” (Jensen 1968, p. 394). To make validinferences about forecasting ability, however, alpha must be standardized by the standard error ofthe estimate. According to Jensen, failure to distinguish alpha different from zero suggests that thepositive alpha was due to random chance, not superior forecasting ability. The standard error ofthe estimate reflects the volatility of the manager’s excess returns; the lower the error rate, thegreater the implied forecasting ability. Model 2 incorporates the three factors described above and adds a dummy variable, whichtakes the value 1 if management has ten or more years experience and zero otherwise. Itscoefficient, βD , captures the marginal excess return generated by these managers. Our tests of performance employ both individual fund alphas and alphas from portfolios ofmutual funds. Portfolios are constructed because investors can reduce volatility for a givenexpected return by diversifying among managers and across investment objectives. Investing in aportfolio of managers who have, in the past, demonstrated an ability to generate positive excessreturns for three years, for example, lowers the error rate, enhancing the possibility of capturingsignificant excess returns if managers maintain their high level of performance. Data The sample consists of 1,042 funds operating during the period 1985 through 1995 andsatisfying the selection criteria listed below. The test sample contains 112 funds whosemanagement had 10 or more years tenure at a fund. The control sample contains 930 funds whose
228 JOURNAL OF ECONOMICS AND FINANCE • Volume 27 • Number 2 • Summer 2003management tenure was less than 10 years.5 Monthly mutual fund returns and the length of eachmanager’s association with a fund were obtained from the April 1997 Morningstar PrincipiaPlus™. The 1,042 funds represent six investment categories in Morningstar; Growth, AggressiveGrowth, Equity-Income, Growth and Income, Small Company, and Specialty Precious Metals. Noindex funds, bond funds, or funds that invest primarily in foreign equities are included. Nine of the 112 funds were managed concurrently by two individuals with the same tenureduring the test period. Two funds were managed by three individuals with the same tenure. Fiveindividuals managed two different funds concurrently and three individuals managed three fundsconcurrently during the 10-year test period. Data for constructing indexes for the three-factor modelused in the study were obtained from the Center for Research of Security Prices (CRSP) andStandard & Poor’s COMPUSTAT (see appendix for details). The proxy for the risk-free investmentin month t is the 12th root of the ask yield on 90-day Treasury bills at the end of month t-1. Results Do managers with longevity at a fund, in this case at least 10 years, generate greater and moreconsistent risk-adjusted excess returns than their less experienced counterparts? This sectionpresents the results from performance tests of individual funds and portfolios of funds for theperiod 1986-95 and for individual years within this period. We also form portfolios of fundsdemonstrating superior performance relative to their peers during the period and examine aninvestment strategy designed to capitalize on short-term performance persistence. Excess Returns Based on Model 1, the pooled sample of 1,042 funds generates a significant, monthly, risk-adjusted, excess return of 0.15 percent, (t=17.61), or a compound annual excess return of 1.81percent. Table 1, Panel A, presents results from Model 2 using a dummy variable that takes thevalue 1 if the fund’s management has at least 10 years tenure and zero otherwise. The coefficientβD in Panel A shows that the marginal excess return generated by these 112 funds is notsignificantly different from that of the control group, -0.01 percent (t = - 0.28). The interceptestimates the average monthly, risk-adjusted return for the 930 funds whose management had lessthan 10 years tenure. This control group generates an average significant, monthly excess return of0.16 percent (t = 17.20), for a compound annual excess return of 1.94 percent.6 Coefficientestimates for the sensitivity of the funds’ portfolios to the risk factors discussed above indicate thatthe excess returns are closely correlated with the market portfolio represented by the CRSP Index. To examine performance consistency, Table 1, Panels B and C report monthly alphas of fundportfolios by year. Panel B shows alphas for the pooled sample of all funds in the sample. Thefunds produce positive and significant excess returns, at the one percent level, in six years, andnegative, significant excess returns in three years. The pattern of significance for alphas, (0, +, -,+, +, +, +, +, -, -), demonstrates a five-year period of during which the group consistently beat theCRSP index on a risk-adjusted basis. An examination of the magnitudes of the positive and 5 The 112 funds represent the total number of unique funds that, for at least one year during the test period, weremanaged by an individual for at least 10 years. See the appendix for a list of funds satisfying this criterion and theirmanagers’ length of tenure. 6 Since the control sample in Table 1 consists of funds managed by individuals with nine years tenure or less, we alsocompared the performance of funds managed by individuals with at least 10 years tenure to portfolios consisting of fundswith managers having a maximum of eight, seven, six, five, four, three, two, and one year(s) tenure. The marginal alphasare not materially different. They are respectively, -0.0003, (t= -0.87); -0.0003, (t= -0.93); -0.0004, (t= -1.07); -0.0004, (t=-1.19); -0.0004, (t= -1.23); -0.0004, (t= -1.22); -0.0005, (t=1.53); -0.0006, (t= -1.72).
JOURNAL OF ECONOMICS AND FINANCE • Volume 27 • Number 2 • Summer 2003 229negative alphas in Panel B suggests that the modest, significant positive alpha for the pooledreturns of the group over the period, reported in Panel A, was made possible by a few good years,particularly 1987, 1992, and 1993. We note that the period 1991 through 1993 represents the onlyyears between 1983 and 1995 that more than 50 percent of active managers outperformed the S&P500. TABLE 1. SAMPLE FUND PERFORMANCE, 1986-95. FUNDS WITH VARYING MANAGEMENT VS. FUNDS WITH UNVARYING MANAGEMENT † Panel A. Pooled monthly performance for sample of 1,042 funds for the period 1986-1995. Student t statistics in parentheses. (Model 2) αi βD βM βS βG Adj-R2 F-stat Prob>F 0.0016 -0.0001 0.9185 -0.1922 -0.2000 0.6195 46,395 (17.20) * ( -0.28) (386.06) * (-57.69) * (-41.45)* <0.000 Panel B. Monthly alphas within annual portfolios for the period 1986-1995 (Model 1) 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 N=642 N=725 N=839 N=888 N=945 N=1,021 N=1,094 N=1,120 N=1,114 N=1,110-0.0005 0.0073 -0.0026 0.0015 0.0029 0.0027 0.0045 0.0068 -0.0028 -0.0062(-1.13) (14.53) * (-7.21) * (6.07) * (5.51) * (7.47) * (16.43) * (16.51) * (-11.89) * (-16.78) * Panel C. Marginal monthly excess returns, (βD), by year, from a sample of 112 funds with unvarying management relative to funds with unvarying management for the period 1986-1995‡ (Model 2) 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 N=52 N=48 N=53 N=54 N=54 N=56 N=61 N=72 N=72 N=860.0004 0.0005 -0.0010 -0.0006 0.0013 -0.0004 -0.0005 -0.0008 0.0003 -0.0004(0.29) (0.30) (-0.91) (-0.71) (1.09) (-0.37) (-0.52) (-0.76) (0.35) (-0.49)Notes: † Unvarying management defined as management that has directed the fund for at least 10 years. ‡ Within a year,only those managers with at least 10 years experience running the fund prior to January are included. * Significant at the 1percent level. N = Number of funds in the portfolio each year. Panel C contains the marginal, monthly risk-adjusted excess return by year for the 112 fundsmanaged by individuals with at least 10 years experience. To be included in the portfolio for agiven year, the manager must have had 10 years tenure at the beginning of the year. These resultsare also obtained from running Model 2, where the dummy variable represents the excess return offunds with managers having at least 10 years tenure. The pattern of performance for both sets offunds is virtually identical. In no year is the marginal excess return, βD, different from zero at anyacceptable significance level. The evidence provides no support for the claim that managers withlong-term associations with a fund provide shareholders with greater, or more persistent,performance than funds that vary their management team over time.
230 JOURNAL OF ECONOMICS AND FINANCE • Volume 27 • Number 2 • Summer 2003 Superior Performance Most mutual fund data providers, including Morningstar, report fund alphas as a performancemeasure, but without regard to significance. As indicated earlier, only statistically significantalphas suggest that the performance of a manager may not have been a random occurrence. Thedecision not to report the significance of the alpha may have less to do with the perception that thereader would not understand the statistic and more to do with the value in identifying those fundsand managers capable of generating excess returns. To determine the annual excess return potential of the best performing funds in our sample,we form portfolios containing only funds producing positive alphas in each year of the 10 sampleyears. Table 2 reports the number and proportion of funds in the sample that generate positivealphas each year and the excess return and significance of holding a portfolio of these funds eachyear. In other words, with perfect foresight regarding each manager’s ability to generate positiveexcess returns, what level of excess return could an investor achieve by holding only the fundsproducing positive alphas? On average, 51.5 percent of the funds in our sample produced positivealphas. The monthly alpha of 0.683 percent for this group represents an annual excess, risk-adjusted return of about 8.5 percent. Investors’ chances of picking a fund producing a positivealpha ranged from one in five in 1994 to about four in five in 1993. Table 2, Panels A and B, present the pooled monthly risk-adjusted excess returns, by year, forthe funds producing positive alphas in each year of the test period. The value for “N =” is thenumber of funds in the sample producing a positive alpha, and the percentage below it representsthe proportion of the sample that produced positive alphas. Portfolios of these funds are positiveand significant at the 1 percent level in all years. As in the full sample, these funds produce thehighest alphas in 1987 and 1993. Table 2, Panel B, presents the marginal excess returns (βD) offunds producing positive alphas and managed by individuals with at least 10 years tenure relativeto the control sample of funds managed by individuals with less than 10 years tenure. The resultschallenge the notion that managers with extensive experience offer more value in two ways. First,in no year do the managers producing positive alphas provide a significantly higher excess return.Second, the proportion of experienced managers producing positive alphas, relative to their peers(58.1 percent), is not significantly greater than the proportion of the less experienced managersproducing positive alphas, relative to their peers (difference = 6.9 percent, t = 0.55). Thecorrelation coefficient for the two sets of proportions is 0.985. In other words, a portfolio of fundsmanaged by individuals with at least 10 years experience could not produce greater excess returnsand, when choosing a manager with this level of experience, the chance of choosing a fund thatwould produce positive alphas was no better than for the less experienced group. The results reveal that, even among the top performers, funds managed by individuals with atleast 10 years tenure offer no greater excess returns, nor greater consistency in performance. Short-Term Performance Persistence The tests to this point presume that investors hold an equally weighted portfolio consisting ofall funds in the sample or sub-sample. In this section our test presumes the investor employs asimple screening technique based on the consistency with which the manager or fund generatespositive excess returns. Popular and academic literature (Volkman and Wohar 1996; Grinblatt and Titman 1993),suggest that managers can demonstrate superior performance for short periods. Our test of short-term performance persistence consists of investing in managers who have produced threeconsecutive positive (though not necessarily significant) annual alphas during a base period. Wecompare the portfolio alpha for the three-year base period with the portfolio alphas over the
JOURNAL OF ECONOMICS AND FINANCE • Volume 27 • Number 2 • Summer 2003 231subsequent three years. The analysis consists of five separate test periods that blanket the varietyof market conditions present from 1986 through 1995. TABLE 2. ANNUAL PERFORMANCE OF FUNDS PRODUCING POSITIVE EXCESS RETURNSPanel A. Pooled monthly alphas of funds producing individual positive alphas for a given year for the period 1986-1995. Percentages of funds posting positive alphas are provided for each year. (Model 1) 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 N=236 N=548 N=207 N=487 N=587 N=596 N=838 N=881 N=221 N=308 0.367 0.756 0.247 0.548 0.621 0.584 0.766 0.787 0.200 0.277 0.0065 0.0096 0.0055 0.0051 0.0089 0.0061 0.0069 0.0082 0.0071 0.0044 (6.28) * (15.94) * (5.86) * (14.17) * (17.55) * (13.42) * (25.03) * (16.93) * (8.41) * ( 8.28) * Panel B. Funds managed by individuals with at least ten years tenure.† Marginal monthly alphas (βD) of funds producing individual positive alphas for a given year for the period 1986-1995 relative to funds managed by individuals with less than ten years tenure. Percentages of funds posting positive alphas are provided for each year. (Model 2) 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 N=21 N=42 N=14 N=28 N=37 N=41 N=52 N=64 N=17 N=30 0.404 0.875 0.264 0.518 0.685 0.732 0.852 0.890 0.236 0.349 -0.0006 -0.0005 -0.0024 -0.0004 0.0002 -0.0019 -0.0013 -0.0013 0.0016 -0.0008 (-0.20) (-0.25) (-0.83) (-0.29) ( 0.21) (-1.43) (-1.45) (-1.15) ( 0.64) ( -0.80)Notes: † Within a year, only those managers with at least 10 years experience running the fund prior to January of the yearare included. * Significant at the 1 percent level. Table 3 presents the results from this “hot hands” test for all funds in the sample. It reports,for example, that 87 funds in the sample generated positive alphas in each of the three years of thebase period consisting of 1986, 1987, and 1988. The portfolio monthly alpha for the base periodwas 0.45 percent, or 5.5 percent compounded annually, which is significant at the 1 percent level.The extraordinary performance extended into the fourth year, when the funds produced, as agroup, a monthly alpha of 0.40 percent, or 4.9 percent, also significant at the 1 percent level. Thislevel of performance did not extend into the second and third years following the base period,however, and the monthly alpha for the group over the subsequent three years is only 0.01 percent,which is not statistically significant. The results show that using the strategy of investing in fundsproducing three consecutive positive alphas during the period 1986-88 would have producedsignificant excess returns in only the first year. The results in Table 3 indicate that, while this strategy would have worked in the first yearfollowing the base period in four of five base periods, subsequent performance, including three-year portfolio returns, is inconsistent. In one case, 1990-92, the three-year performance followingthe base period produced significant negative excess risk-adjusted returns.
232 JOURNAL OF ECONOMICS AND FINANCE • Volume 27 • Number 2 • Summer 2003 TABLE 3. PERFORMANCE PERSISTENCE OF FUNDS PRODUCING POSITIVE EXCESS RETURNS FOR THE PERIOD 1986-95 (MODEL 1) Number of funds with Portfolio positive alpha Portfolio alphas in subsequent years c Portfolio alphas in (t-stat) (t- stat) alpha (t-stat) each year during for three years Three-year of base base following a base period period period b 1989 1990 1991 1992 1993 1994 1995 base period d 1986-88 87 0.0045 0.0040 -0.0009 0.0009 0.0001 (3.95) * (3.49) * ( -0.33) (0.46) (0.13) 1987-89 99 0.0059 -0.0002 0.0012 0.0040 -0.0009 (6.71) * ( -0.07) (0.68) ( 3.25) * (-1.25) 1988-90 76 0.0037 0.0054 0.0098 0.0087 0.0064 * * * * (7.89) (4.75) (11.40) (7.34) (11.86) * 1989-91 235 0.0047 0.0071 0.0067 -0.0043 0.0030 (17.96) * (14.85) * (11.23) * (-10.21) * (11.06) * 1990-92 357 0.0051 0.0067 -0.0038 -0.0036 -0.0006 (24.47) * (13.88) * (-10.69) * (-6.62) * (-3.22) *Notes: a Base period contains funds producing positive, risk-adjusted excess returns (alpha) from Model 1 during everyyear of a three-year base period. Model 1 is used to generate fund alphas during each year of the base period. b Forexample, the 87 funds with positive alphas during each year of the three-year base period 1986-88 generated significantmonthly excess risk-adjusted returns of 0.40 percent in 1989. c For example, the 87 funds with positive alphas during eachyear of the three-year base period 1986-88 did not generate monthly risk-adjusted excess returns during the period 1989-91. * Significant at 1 percent level. * * Significant at 5 percent level. Our test results provide evidence supporting a short-term hot hands effect, but our majorconcern is whether managers with at least 10 years tenure provide greater value or are moreconsistent than their less experienced peers. Table 4 results are structured in the same fashion asthose in Table 3, except the values report only the marginal alphas from the dummy variable inModel 2 where βD, i is one if the fund is managed by an individual with at least 10 years tenure,zero otherwise. Table 4 reports the marginal difference between the returns of managers with more than tenyears tenure and those with less experience. The results in Table 4 do not support the notion thatmanagers with lengthy tenure provide greater excess risk-adjusted returns or greater consistencythan their less experienced peers. Using the 1986-88 base period as an example, nine funds fromthe group with 10 years tenure produced positive alphas for the base period. Their subsequentperformance, for individual years and for the three-year period following 1988, indicate thesemanagers excelled beyond their less experienced peers, producing a three-year monthly alpha of0.65 percent, or 8.1 percent annually, significant at the 1 percent level; yet the period 1989-91appears to be an anomaly. Performance in the subsequent test periods suggests that, in general,these experienced managers do not provide greater excess returns, or greater consistency, thantheir less experienced peers.
JOURNAL OF ECONOMICS AND FINANCE • Volume 27 • Number 2 • Summer 2003 233 TABLE 4. MARGINAL PERFORMANCE OF FUNDS MANAGED BY INDIVIDUALS WITH AT LEAST 10 YEARS TENURE RELATIVE TO PERFORMANCE OF MANAGERS WITH LESS EXPERIENCE (MODEL 2) Number of Marginal funds with Marginal Marginal portfolio performance in subsequent years c portfolio positive portfolio (t-stat) performance alphas performance (t-stat) for in each year (t-stat) three yearsThree-year of base during base followingbase period period a period b 1989 † 1990 1991 1992 1993 1994 1995 base period d 1986-88 9 -0.0009 0.0056 0.0039 0.0100 0.0065 (-0.28) (1.73) * * * ( 0.82) (2.13) * * (2.60) * 1987-89 8 0.0013 0.0035 0.0108 -0.0006 0.0046 ( 0.43) (0.73) (2.25) * * (-0.18) (1.79) * * * 1988-90 12 -0.0015 0.0023 -0.0018 -0.0008 -0.0001 (-0.91) (0.73) (-0.74) (-0.30) (-0.06) 1989-91 11 0.0008 -0.0015 0.0007 -0.0003 -0.0005 ( 0.68) (-0.89) ( 0.40) (-0.21) (-0.52) 1990-92 18 -0.0010 0.0013 -0.0002 0.0005 0.0007 (-1.07) ( 0.91) (-0.14) (0.36) ( 0.90)Notes: a Base period consists of funds producing positive, nonthly, risk-adjusted excess returns (alpha) from Model 1 inevery year of a three-year base period. Model 1 is used to generate alphas for each year of the three-year base period. b Thedummy variable from Model 2 measures the marginal post-base period performance of managers with at least 10 years at afund relative to the performance of funds managed by individuals with less than 10 years tenure. c For example, the ninefunds producing positive alphas during each year of the three-year base period 1986-88 generated significant monthlyexcess, risk-adjusted returns 0.56 percentage points higher than funds managed by individuals with less than 10 yearstenure. d For example, the nine funds producing positive alphas during each year of the three-year base period 1986-88generated significant monthly excess, risk-adjusted returns 0.65 percentage points higher than funds managed byindividuals with less than 10 years tenure. † Within a year, only those managers with at least 10 years experience runningthe fund prior to January are included. * * Significant at 5 percent level. * * * Significant at 10 percent level. Summary and Conclusions If the longevity of a fund manager is related to ability to provide superior performance, themanager’s tenure at a fund should be a factor in explaining the size and persistence of fundreturns. Using the methodology which controls for returns on the market portfolio, marketcapitalization, and a value component, we show that a portfolio of 1,042 mutual funds generatespositive, significant risk-adjusted annual excess returns of about 1.81 percent between 1986 and1995, a period which included the bull market of 1986 and 1987, the crash of 1987, a recession,and the initial stages of the bull market of the late 1990s. Though mutual funds and financialadvisors generally tout the value of managers with lengthy experience at a fund, the 112 fundsemploying 115 managers with at least 10 years tenure at a fund within a given year were unable toprovide greater, or more persistent, positive, excess risk-adjusted returns than a control groupcontaining funds with active managers having less experience. While portfolios containing mutual funds from each group generate similar positive, excessreturns over the test period, persistent, positive excess returns are elusive for even the bestmanagers. Our tests reveal that the chances of selecting a fund that will produce a positivesignificant alpha in a given year are, on average for the period, about 50 percent, and the chancesof selecting a fund that will produce a positive alpha from the sample of managers with at least 10years tenure is not significantly different.
234 JOURNAL OF ECONOMICS AND FINANCE • Volume 27 • Number 2 • Summer 2003 Results from short-term performance tests yield little evidence that extraordinary performancecan be maintained by either group of funds. Instead, excess returns tend to be concentrated in afew crucial years. Without regard to manager tenure, funds generating significant excess returnsover a three-year base period are not likely to produce positive and significant risk-adjusted excessreturns in the subsequent three-year period. The results for a three-year base period and postperiod are not consistent with short-term performance persistence evidence by Goetzmann andIbbotson (1994) or Volkman and Wohar (1996). However, our tests reveal that using a three-yearbase period to predict performance in the subsequent year is valuable, though managers with atleast 10 years tenure perform no better than their less experienced colleagues, in general. The results from this study suggest that, while the excess returns of funds operating during theperiod between 1985 and 1995 produce positive excess returns, the risk-adjusted excess returns offunds managed by individuals with at least 10 years tenure are not different from those of fundswith varying management. Neither group demonstrates a record of consistency. Consequently, wefind no compelling reason to believe that manager tenure is a proxy for expertise that producessuperior or consistent performance. ReferencesBrown, S. J., and W. N. Goetzmann. 1995. “Performance Persistence.” Journal of Finance 50: 679-698.Carhart, M. 1997. “On Persistence in Mutual Fund Performance.” Journal of Finance 52: 57-86.Elton, J., M. Gruber, and C. Blake. 1996a. “Survivorship Bias and Mutual Fund Performance.” The Review of Financial Studies 9: 1097-1120.Elton, J., M. Gruber, and C. Blake. 1996b. “The Persistence of Risk-Adjusted Mutual Fund Performance.” Journal of Business 69: 133-157.Elton J., M. Gruber, A. Das, and M. Hlavka. 1993. “Efficiency with Costly Information: A Reinterpretation of Evidence from Managed Portfolios.” The Review of Financial Studies 6: 1-22.Fama, E., and K. French. 1993. “Common Risk Factors in the Returns on Stocks and Bonds.” The Journal of Financial Economics 33: 3-55.Grinblatt, M., and S. Titman. 1993. “Performance Measurement without Benchmarks: An Examination of Mutual Fund Returns.” Journal of Business 66: 47-68.Goetzmann, W., and R.G. Ibbotson. 1994. “Do Winners Repeat?” Journal of Portfolio Management (Winter): 9-18.Gruber, M. 1996. “Another Puzzle: The Growth in Actively Managed Mutual Funds.” Journal of Finance 51: 783-810.Jensen, M. C. 1968. “The Performance of Mutual Funds in the Period 1945-1964.” Journal of Finance 23: 389-416.Khorana, A. 1996.”Top Management Turnover: An Empirical Investigation of Mutual Fund Managers.” Journal of Financial Economics 40: 403-427.Malkiel, B. J. 1995. “Returns from Investing in Equity Mutual Funds 1971 to 1991.” Journal of Finance 50: 549-572.
JOURNAL OF ECONOMICS AND FINANCE • Volume 27 • Number 2 • Summer 2003 235Porter, G. E., and J. W. Trifts. 1998. “The Performance Persistence of Experienced Mutual Fund Managers.” Financial Services Review 7: 57-68.Smart Money. 2002. (August): 21.Volkman, D., and M. Wohar. 1996. “Excess Profits and Relative Strengths in Mutual Fund Returns.” Review of Financial Economics 5: 101-116.Wermers, R. 2000. “Mutual Fund Performance: An Empirical Decomposition into Stock-Picking Talent, Style, Transaction Costs, and Expenses.” Journal of Finance 55: 1655-1703. Appendix The construction of both the size and book-to-market equity portfolios follows themethodology of Fama and French (1993). To construct the difference in return between an equallyweighted small-capitalization portfolio and a large-capitalization portfolio (Rs - Rl) for everymonth of year s, we first construct five size-based portfolios. The five portfolios are constructedfor year s based on market equity (ME = stock price time shares outstanding) from June of year susing CRSP data.7 Quintiles are constructed based on the ME of all NYSE and AMEX listedfirms. Returns are then computed for all NYSE, AMEX, and NASDAQ firms in the largest andsmallest quintile from July of year s to June of year s + 1. If a firm is delisted during year s, thenthe month that firm is delisted, the return is set to zero and the next month the sample size isreduced by one. To construct the difference in returns between a high-growth portfolio and a value portfolio inyear s by month, (Rg - Rv), we construct five portfolios based on the book-equity to market-equity(BE/ME) ratio.8 To ensure that the accounting variable (book equity) is known before the returns itis used to explain, BE is calculated from COMPUSTAT for fiscal year no later then December ofyear s -1. Market equity is calculated based on CRSP data from June of year s. Then, based on theratio of BE/ME, we calculate returns from July of year s to June of year s + 1 for the largest andsmallest quintile. Therefore, to be included in the sample, a firm must have CRSP stock prices andshares outstanding for June of year s and COMPUSTAT shareholder equity (BE) for fiscal yearending in year s - 1. If a firm is delisted during year s, then the return for the month delisted of thatfirm is set to zero and the next month the sample size is reduced by one. 7 Search CRSP data starting at June 30 for year s. If there is no information for share price or number of sharesoutstanding for the entire month of June, then the stock is dropped from the sample. 8 This value is book equity (COMPUSTAT item # 60) less deferred taxes (item #74). Market equity is defined asshare price, end of June, year s, times shares outstanding.
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