The star portfolio manager is a curious phenomenon. It is something my colleague, Julie Segal, and I discuss quite often. All the more so during the drama of the past two weeks. The Bill Gross–PIMCO dustup — and bond legend Gross’s departure to Janus Capital Group, where he started today — shows just how vulnerable even a $1.9 trillion asset management firm can be to its talent.
For an asset management firm, how valuable is the star system? Do personality portfolio managers really perform better, or can a team approach be just as effective? And how many truly best-in-class money managers are there? After all, by definition most people are going to be at or below average, and in the benchmarked asset management industry it is notoriously hard to consistently outperform over time.
The appeal of the star system is obvious. Stars are marketable. Yes, they might also be good stock pickers or bond investors, but the investment business is also about telling stories. People — individual or institutional investors — like to invest in people. When we write about asset managers — as I just did in my feature on Canyon Partners, “Canyon Capital Thrives in a Transforming Financial Landscape,” for example — we write about the process and what they do. But for me at least, the more compelling parts of the story concern the personalities themselves. There is good reason for this. It’s not just that people are easier to relate to than investment concepts or capital structures, though that is true. As a fiduciary or an individual investor, you want to have confidence in the person managing your money. People can also go on TV. Bill Gross might have been reluctant to travel east of the Rockies, but he was, and no doubt will continue to be, a genius at appearing on CNBC and talking about the bond market.
Under Daniel Ivascyn, who has replaced Gross as CIO, PIMCO understandably now plans on moving away from the star system. The emphasis, as the Wall Street Journal explained when it scored one of the first interviews with Ivascyn, will now be on the team. For a large asset manager like PIMCO or, even more so, its parent, the German insurance company Allianz, the team approach has a lot of advantages. Mostly, people are annoying. They do things like demand more money (Gross’s annual salary was reportedly $200 million), leave and start their own firms (as in the case of Jeffrey Gundlach and TCW Group) or lose their edge. From a business risk perspective, it’s preferable to have a good, anonymous institution for which the brand name is the calling card. Of course, you have to have a brand to pull that off, which is one reason why the PIMCO-Janus face-off is going to be so fascinating. PIMCO has the brand but no longer has the star, whereas Janus has the faded star but not the brand. PIMCO has already suffered some $23.5 billion in redemptions from its flagship PIMCO Total Return Fund. It remains to be seen what Janus’s inflows will be like.
So, do star managers add value over time? Obviously the exceptional ones like Gross and Gundlach do. But the evidence for consistent outperformance is less clear. A recent study by Jack Trifts, professor of finance at Bryant University, and Gary Porter, associate professor of finance at John Carroll University’s Boler School of Business, suggests not.
Trifts and Porter looked at the career trajectory of equity mutual fund managers, focusing on individual — or star — managers, rather than the funds themselves. What they found is that, although star portfolio managers who underperform the market do not last very long, very few managers consistently beat the market over ten years or more.
The study makes for some depressing reading. Their data set consists of actively managed stock mutual funds run by a solo manager from 1995 onward. There are 2,551 funds whose managers lasted nine years or less, and just 195 with a solo tenure of ten years or more. Only 6.85 percent of managers in that universe lasted a decade or more; more than three quarters, or 76.95 percent, lasted no more then five years. As you would expect, those who dropped out early had notably poor performance: Those managers who lasted no more than one year had a style-adjusted return of minus 0.074 percent relative to the markets.
On a risk-adjusted basis, those fund managers with a tenure of ten years or more did outperform those with shorter spans, but Trifts and Porter found that when measured using the four-factor Carhart model of analysis, which adjusts for style and size, “the ten-plus-year managers actually earned negative average alpha in seven of their first nine years.” In other words, most active managers suck. And, as Trifts and Porter note, their results suggest “that longevity as a mutual fund manager is more related to one’s ability to not underperform one’s peers than to the ability to outperform the market.”
As Trifts tells me, “There are a handful of managers who, over long periods of time, have beaten the market on a risk-adjusted basis. Those are very few and far between, and, frankly, it is very difficult to tell whether they beat the market because they truly were exceptional” or the outcome was just due to randomness. The data also suggest that very often the great long-term managers were managers who did exceptionally well earlier on in their careers, only to be average ever after.
Of course stocks and bonds are different, and it would be interesting to see such an analysis applied to the stars of the bond markets. Yet the preponderance of evidence that few active managers outperform over time remains a powerful argument in favor of indexing. For Trifts, the most interesting aspect of his research is what it means for aspiring portfolio managers. “I teach business school,” he says. “A lot of these students want to manage money.” But from the findings of this study and others, “perhaps what we should be doing is trying to convince them to do something else, because there is such an incredibly low success rate” in active management, he adds.
A major reason that outsize returns are so hard to achieve in traditional active management has to do with the constrained nature of the mandate and the need to hug a benchmark. I’d wager that most of Trifts’s students who want to get into money management see themselves in the less constrained, and potentially much more lucrative, alternative investment field. The ascent of alternative investments, hedge funds and private equity managers has taken the notion of the star portfolio managers to a whole new level. One where Gross’s $200 million looks almost conservative. Almost.
Follow Imogen Rose-Smith on Twitter at @imogennyc.