Manager Picking

Can Managers Pick Managers?

Manager Picking

Your mother may have taught you that cheaters never prosper, but what about copycats? When it comes to mutual fund managers, the answer is sometimes, but not for long, at least according to three researchers from the US and the UK who released this paper quantifying the long-observed copycat phenomenon among mutual funds.

Using mutual fund data from the Center for Research in Security Prices between 1991 and 2013, the authors identified “copycat funds” as those whose trades matched a target fund by 75% to 90% in two or more consecutive periods. They looked at the performance of both the copycat and the target funds before and after the commencement of the copying. The results are summarized in the chart below:

As expected, the copycat funds suffer from negative alpha and thus choose to copy a fund with positive alpha. The target fund appears to benefit from the copying, perhaps because the securities it owns are bid up in price by the copycats. Furthermore, the copycats also derive a benefit in that most of their negative alpha is erased. Unfortunately, both of these effects are temporary, as reversion to the mean dominates. The decreases in returns were found to be statistically significant for both the copycats (95% confidence level) and the targets (90% confidence level). The negative alphas of the copycat funds at the beginning and end of the periods were significant at a 99% confidence level. It appears to be just a coincidence that the alphas of the copycat funds were exactly the same in the year before copying and in the fourth year of copying. As bad as we feel for the managers of the copycat funds, we can only feel worse for their investors. The positive alphas of the target funds were only significant for the first year after copying (90% confidence level). Regarding the implications of their results, the authors state:

“We note that our results do not imply that superior mutual fund managers do not exist, just that ex ante identification, if possible, is extremely difficult and few investors possess this ability.”

Of course, if other fund managers who have the necessary training, time, access to private information on their peers, and expertise are unable to detect superior funds, then there is no practical hope for both retail and institutional investors. If you are currently on the manager-picking treadmill and would like to learn about a better way to invest, please call us at 888-643-3133.