Mutual Fund Performance and Board Characteristics Relating to Manager Terminations
Nenninger, Steve A., Academy of Accounting and Financial Studies Journal
This study examines mutual fund performance around fund manager replacement and the timing of the decision to replace mutual fund managers. Fund manager replacement timing is explored to test whether quick actions by boards of directors mitigate the negative fund performance characteristics usually associated with manager replacement. The study includes data from 507 instances of replacement of an individual fund manager or the entire management team. While results match previous findings that returns improve and standard deviation falls following a manager change, several important new findings are also presented. In using a unique control sample of funds matched on prior period performance, net assets, and investment objective, it is shown that poorly performing managers who retain their positions actually improve fund performance to as great a degree as the new managers hired after a termination. Both groups experience improved returns and lower standard deviation of monthly return after the replacement date.
Further, evidence indicates that for boards which decide to replace poorly performing managers, stronger boards are more likely to complete the replacement early in a period of underperformance. That is, boards which have a larger percentage of independent directors and which are smaller tend to be associated with early terminations.
Mutual funds experiencing poor performance often replace the fund manager in an effort to improve returns. Managers who are underperforming are therefore motivated to increase performance in order to retain their position. While this may initially appear to align managers' goals with those of shareholders, a deeper examination is required. Fund managers who are underperforming may feel a need to focus exclusively on short-term results, and therefore increase risk in a gamble to boost returns (Chevalier and Ellison (1997), Brown, Harlow, and Starks (1996)). If the gamble pays off, the manager may keep his position, while if the gamble fails, he only loses a position which he was destined to lose anyway. An underperforming manager who remains in place for several years may compound the severity of the problem, resulting in a trend of increasing risk, lower performance, and lower asset flows.
Prior research has shown that performance and flows generally increase and risk decreases following a manager replacement (Chevalier and Ellison (1999), Khorana (1996) Khorana (2001)). The improvement is usually credited to the new manager. However, in this paper I compare funds which have changed managers to a matched set of funds which have not replaced managers in order to determine whether poorly performing funds which retain their managers also experience improved performance. This study is unique in determining a control group of funds with similar performance rather than comparing the "change" funds to a much broader control group based solely on investment objective. Therefore, the first question addressed in this paper is whether credit should be given the new manager or if there is a general mean reversion that occurs in underperforming funds over time.
Results indicate that after the manger replacement date, performance, asset flows, and risk are very similar for the funds which replaced their managers and the control group. Excess objective returns approach 0 for both groups in the post-replacement period, a significant increase from negative excess objective returns prior to the manager change. Flows, which appear to follow lagged return, fall during the pre-replacement period, then also increase after the replacement date.
Secondly, since prior studies have shown that a manager replacement is a positive event for a struggling fund, the timing of the decision to replace mutual fund managers is examined. I test whether more timely reactions by boards of directors mitigate the negative fund performance characteristics usually associated with manager replacement. …