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Course 209
Why Knowing Your Fund Manager Matters

Introduction

Everyone remembers the glory days of Notre Dame football. In the late 1980s and early 1990s, under the watch of head coach Lou Holtz, the Fighting Irish team was a college powerhouse to be reckoned with. During his 11-season tenure, Holtz boasted an admirable 0.765 winning percentage and led the Irish to a national championship in 1988 (and fell just shy of capturing the crown in 1989 and 1993).

But all good things must come to an end. Holtz left in 1997. His replacement, Bob Davie, was never able to find his groove as the Irish spun to a virtually unheard of 25 losses during his five-year stint, and succeeding coaches have had mixed records at best.

Fund investors can learn something from this reversal of fortune. Like college football teams, mutual funds are only as good as the people behind them: the fund managers. Portfolio managers are the people who decide what to buy and what to sell, and when. Because the fund manager is the person who is most responsible for a fund's performance, knowing who's calling the shots and for how long is key to smart mutual fund picking.

Different Manager Structures

Before discussing further why managers are important, let's step back and examine the three ways in which funds can be managed.

First, there's the single-manager approach. In this setup, one person takes primary responsibility for making the fund's investment decisions. The manager doesn't do all the research, trading, and decision making without help from others, though. For example, Harry Lange is still listed as the sole manager of Fidelity Magellan FMAGX, but Fidelity's analysts feed him plenty of stock ideas. The single manager is sole decision maker, not the sole idea generator.

Second, there's the management team, first popularized by families such as American Century, Dodge & Cox, and Putnam. Here, two or more people work together to choose stocks. The level of one team member's involvement or responsibilities can be tough to gauge, though. Sometimes there's a lead manager who is the final arbiter, while other times it is more of a democracy.

Third, and most rare, there is the multiple-manager system. The fund's assets are divided among a number of managers who work independently of each other. American Funds is the biggest fund family using this approach. Multiple managers are more common with funds managed by firms other than the fund company itself, such as Vanguard Windsor II (VWNFX) or Managers Investment Group funds.

Why Managers Matter

We think it is always important to know who a fund's manager is, whether the fund is run by one person or a whole team. Equally important is how long the person or team has been running the fund. Make sure that the manager who built the majority of the fund's record is still the one in charge. Otherwise, you may be in for a surprise.

For example, Oppenheimer International Small Company (OSMAX) is likely to look very different following the departure of Rohit Sah in February 2011. Sah had a distinctive, bold style, and although it backfired occasionally, over time it provided excellent returns. Instead of searching for a single replacement, two managers from Oppenheimer will lead a team of seven, each of whom will contribute ideas. The fund may still end up being a solid option, but it won't likely have the same unusual style it did under Sah going forward.

Of course, not every manager change is a cause for potential concern. Matthews Pacific Tiger remained one of our favorite Asia focused funds even after it shuffled its management team at the start of 2008. Mark Headley, who came on board as a comanager in 1996 and took the helm several years later, gave up his lead manager position at that time for health reasons. That was a blow, as Headley is one of the most seasoned and skilled Asia investors around. But he stayed involved with the fund as a comanager. Moreover, we had ample reason to believe in the two new lead managers, Richard Gao and Sharat Shroff, who had good records at the fund's siblings. Indeed, over the trailing three years through May 2011, Matthews Pacific Tiger has gone on to beat more than 90% of its peers..

Where Managers Matter Most--and Least

If you're looking for new investments and find two equally good funds, choose the one with the more experienced manager. But if the manager of a fund you already own jumps ship, it's not always best to sell the fund immediately.

First, you may have to pay taxes on your sold shares, if they gained in value, and what you give up in taxes may not be offset by extra future gains in a different fund. Second, the new manager may do just as well as the old. Finally, some types of funds are simply less affected by manager changes than others. Here are some examples:

Index Funds. Managers of index funds are not actively choosing stocks, but simply mimicking a benchmark by owning the same stocks in the same proportion. As such, manager changes at index funds are less important than manager changes at actively managed funds.

Funds in Categories with Modest Return Ranges. Managing an ultrashort-bond fund is a game of basis points. (A basis point is one one hundredth of a percentage point.) In other words, because ultrashort bonds don't offer much return potential, the difference in return between a great and an awful ultrashort-bond fund is a matter of one or two percentage points. So if your ultrashort-bond fund manager leaves, it's probably not a big deal.

Funds from Families with Strong Benches. When a fund manager leaves T. Rowe Price, we generally don't get very upset. Why? Because T. Rowe has many talented managers and analysts who can pick up the slack. Manager changes aren't quite as troubling if you're talking about a fund from a family, such as Fidelity, T. Rowe Price, and American, with a number of good funds and a strong farm team.

Funds Run by Teams. While this isn't always the case, you'll often find that funds run by teams are less affected by manager changes than funds run by only one person. But that's only true if the fund really was run in a team fashion, in which decisions were truly democratic.

Conversely, then, manager changes can be a crushing blow to other types of funds. Investors who disregard managers and manager tenures in the following types of mutual funds may find themselves much worse off than a disappointed sports fan.

  • One-manager funds.
  • Funds run by very active managers who've proved to be adept stock-pickers or traders.
  • Good funds from families that aren't strong overall, or from fund families that lack other strong funds with a similar investment style.
  • Funds in such categories as small growth or emerging markets, where the range of possible returns is very wide.

Quiz 209
There is only one correct answer to each question.

1 Funds following the multiple-manager system:
a. Use two or more people who work together to choose investments.
b. Use two or more people who work independently of each other to choose investments.
c. Use one lead manager and a group of traders and research analysts.
2 Which type of fund is least affected by manager changes?
a. Index funds.
b. Funds in categories in which the range of return is wide.
c. Funds from families that lack depth.
3 Which type of fund is most affected by manager changes?
a. Funds in categories with modest return ranges.
b. Funds run by teams.
c. One-manager funds.
4 If you're choosing between two equally good funds, do not choose the one:
a. From a fund family that's strong overall.
b. Run by a single manager who's the only star in the fund family.
c. That clearly identifies the length of the manager's tenure.
5 When a manager leaves a fund you own, you should:
a. Sell immediately.
b. Hold on.
c. It depends.
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