Has your fund manager decided to exit the fund house?

If you suddenly read the news that the fund manager has decided to move on, what would you do? To answer this question, you need to address 3 critical issues. Here is a template.

Nov 29, 2019 10:11 IST India Infoline News Service

You have been invested in a mid cap fund for the last 5 years and your fund manager has never disappointed you. If you suddenly read the news that the fund manager has decided to move on, what would you do? Should you stay invested in the fund or should you move out just because the fund manager has moved out. Should you rely on the fund manager as an individual or should you rely on the ecosystem created by the fund. To answer this question, you need to address 3 critical issues. Here is a template.

How much of the outperformance was due to the fund manager?
In India, fund managers are larger than life personalities because we attribute most of the outperformance to a fund manager just as we attribute underperformance also to the fund manager. But that may not always be correct. Here is how you can apply a test.

In the case of a fund manager you must always judge by how they protect capital in tough times than by how they outperform in good times. For example, between 2003 and 2007, most of the fund managers who just bought large caps and held on managed to perform extremely well. But periods like 2008 to 2011 and more recent phases like 2017 to 2019 have been a lot more challenging. This is the phase wherein a fund manager should be judged.

Then there is the risk aspect. For example, your fund manager may have outperformed the index by 4% last year. That sounds great but if that has come about with a Beta of 1.5, then you are exposed to inordinate risk. Things could really backfire when the tide turns. That is where measures like Sharpe and Treynor are more reliable because they focus on risk-adjusted returns.

One more thing you can do is to delineate how much of the returns came from skill and how much came from luck. For example, fund managers who started out in 2003 and got evaluated in 2007 may end up looking extremely smart. But most of the returns would have come due to the momentum of equity as an asset class. When your fund manager quits, you need to break-up the performance and see how much is coming from genuine skill and how much from luck or higher risk. There are Fama models that can break up the alpha. If dame luck is the answer, don’t worry too much.

Does the fund house have the right ecosystem?
This is the logical next question. What do we mean by an ecosystem? At the end of the day, fund managers are the face of the scheme but they are not entirely the heart and soul of the scheme. Investment decisions in a mutual fund are approved by an investment committee, which includes the CIO, CEO and outside experts too. It is here that the actual strategy gets formalized. If the fund house has the right ecosystem to generate solid ideas and to manage its risk properly, then the right ecosystem is in place. You don’t have to overly worry about the exit of a particular fund manager. A strong ecosystem can handle such exits smoothly without jeopardizing the performance of the fund.

Is the exit of the fund manager, one-off, or is there a trend?
This is perhaps the most relevant question you need to ask yourself. In the last few years we have seen a number of funds where there have been a series of fund manager exits. That is not good news because it could have larger implications. The sponsor may be losing interest in the fund management business and may be looking for an exit. Alternatively, there may be issues with the portfolio mix of the fund and fund managers may be moving out before a crisis of larger proportions erupts. When you find a series of fund manager exits, it is normally not a very good sign and even the equilibrium within the organization could get impacted. That is when you need to be cautious about your fund holdings.

In the last 2 decades, there have been enough instances of star fund managers who left a fund but could never replicate their old level of success. If one fund manager could really make a difference, then hedge funds would not be struggling and passive funds would not have become so popular. In a fund house with the right ecosystem, the occasional exit does not make much of a difference. Just don’t lose sight of your long term goals!

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