Second-career mutual fund managers can use their previous expertise well

LAWRENCE — When mutual fund managers are armed with expertise from previous careers outside the financial sector, they can use that information to generate an investment advantage, according to a study led by a University of Kansas finance professor.

While the researchers found evidence of an adjusted 5 percent return per year over competition, that advantage was limited to when these experienced managers pick stocks in sectors of their specialty, not when they pick stocks in other sectors. In other words, if they are employed to focus on investing in what they know well — such as an engineering field, energy or the health care sector —  the risk could be worth it for mutual fund families.

"We are trying to better understand the human capital of mutual fund managers and the characteristics that go into it. This one has not entirely been explored," said Gjergji Cici, associate professor of finance and dean's fellow in the KU School of Business. "Another thing that got our attention was that a lot of mutual fund families advertise the fact they have mutual fund managers or analysts with this kind of experience. We wanted to see if the claims made by these families were justified."

The group's findings will appear in the October issue of the Review of Financial Studies. Cici's co-authors are Monika Gehde-Trapp of University of Mannheim - Finance Area, Marc-André Goericke, University of Cologne, and Alexander Kempf, University of Cologne - Department of Finance & Centre for Financial Research.

The researchers collected detailed biographical information on 1,295 mutual fund managers who single-managed equity funds. Of those they identified about 10 percent, or 130 mutual fund managers, with prior experience outside the financial sector.

Although industry experience gives fund managers a clear investment advantage in certain sectors, only about a tenth of diversified funds are run by managers with industry experience, the researchers found.

It's possible that fund families hire more managers with specialized experience but allocate most of them to sector funds where they can use their experience to pick more specialized stocks in areas where they can use their knowledge and experience, Cici said.

"The rationale would be that managers of diversified funds have to diversify across industries and are constrained from utilizing their industry experience to the fullest," he said.

Within sectors where these experienced managers specialized in their prior careers, the researchers found evidence that their superior information embedded in their trades was impounded into stock prices slowly, which suggests their information is unique and perhaps takes time for markets to discover it.

The researchers also found that having advanced in their prior industry further helped these experienced managers perform better when leading mutual funds, suggesting this gives managers more access to information in the sector and how to handle investment decisions in their new career.

The lesson for investors when considering advertising pitches from mutual fund companies that tout specialized experience of their managers is to give the idea more weight when considering a specialized fund instead of a general one.

"If a manager's industry experience was in technology, it's better to put him or her in charge of a technology sector fund as opposed to a diversified sector fund, where he or she will not use their expertise and advantage as much," Cici said.

Another implication of the study could be for mutual fund companies to seek to replicate this type of specialized industry experience without relying on people from outside sectors to change careers. The pool of candidates is likely somewhat shallow because it does require time to train as an investment expert on top of their previous industry experience, Cici said.

Some companies have started to give analysts time to embed in other industries, like retail chains, for example, seeking to help them acquire specialized industry experience, he said.

"Not a lot of people want to make this career switch," Cici said. "So, is there a substitute for this kind of experience and another way to get your analysts or managers to acquire this type of experience?"

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