Effects of Fund manager reputation, track record, and skill on funds returns and capital flows

Question

I am compiling a list of all studies that examine the effects of fund manager reputation, track record and skill on fund returns and capital flows across both mutual funds and hedge funds. The purpose is to look at the difference in the results these studies propose and the different models used to study reputation and track record.

Can you post some of the most notable works in this field of research? I have several papers already, but i just want to make sure i have a complete overview.

Thanks

Answer 1

Two of the most cited papers are Sirri, E.R., Tufano, P., 1998. Costly Search and Mutual Fund Flows. Journal of Finance 53 (5). 1589–1622 and Chevalier, J., Ellison, G., 1997. Risk Taking by Mutual Funds as a Response to Incentives. Journal of Political Economy 105 (6). 1167–1200.

Answer 2

For hedge funds, the main factors that drive capital flows are (not sure about actual research papers) ...

1. Risk-adjusted performance (over prior 4-6 years) is very strongly correlated to capital flows and by far the most dominant factor. Absolute return is mostly ignored, unless the absolute return is very low (i.e. sub 5%) and similarly leverage is mostly ignored, unless the leverage is super high. Reputation matters very little except perhaps for new launches - in fact Reputation builds up mostly on the backs of risk-adjusted performance. Its common for a lot of investors to rank hedge fund managers (by Sharpe Ratio) over two disjoint non-overlapping 3-4 year periods (e.g. 2008-2011 and 2011-2014 would be two such 3-year periods). This is usually done via a double sort. As managers start to rank high on both disjoint periods they see assets rise, and vice versa. You will find most super large hedge funds also rank among top quartile funds in such two disjoint periods (i.e. they are large for a reason!). Exceptions are activist hedge funds, which are really private equity investors operating as hedge funds and their investor audience is usually family offices who prefer high magnitude of returns rather than institutions.

2. Another related performance measure that quite a few investors look at is percentage of rolling 12-month periods that a fund was positive. (e.g. a 60 month track record will give 49 rolling 12-month return numbers). A lot of top funds are positive only around 51%-52% of the individual months, but once you convert it to rolling 12-month returns, the percentage rises to 80%. The idea here is that what is the probably that once you invest, the manager will likely be positive a year from now. Longer periods >6 years are used, because there are many carry-like funds (FX managers, Fixed Income RV, Convert RV managers) who are positive quite a lot for a while, and then tend to blow up in every bear market.

3. So conditioning on the strategy that the manager follows, e.g. fixed income rv, macro, equity long/short, convert arb, mortgages will explain capital flows further. This will also largely account for the effect that a hedge fund manager holds too much illiquid assets, etc.

4. Another thing that matters a lot in the hedge fund world is Ratings by Prominent Consultants like Albourne. If a manager gets rated A or upgraded by Alborne, even if they are vanilla, they will see a lot of assets flowing to them. Downgrades usually result in serious loss of assets.

5. Another key criteria is whether the manager is below or above a magical AUM of USD 100mn. A lot of large investors have restrictions from investing with hedge funds less than USD 100mn irrespective of performance. Some super-large pensions are limited to hedge funds with AUM more than USD 500mn. So use a dummy variable for AUM less than USD 100mn and that should give you a good additional factor to explain capital flows.

6. Most investors avoid a 1-man investment team shops or less than 2-man operations team shops. Too small size of the team could be another minor factor to explain capital flows.

7. Other minor factors would include: any unique operational issue or unusual conflicts (e.g. a SEC ruling on any PM), whether the manager allows managed accounts or not, annual redemption is a dead no for many investors, but these factors could be hard to capture.