Want Better Returns? Check Your Manager’s Resumé

Academic research has found managers really should stick to what they know—and the more they know, the better the returns.

Experience outside of the investment world can boost a fund manager’s performance, research has shown—as long as they invest in the area they once worked in.

The findings were published by Gjergji Cici, Monika Gehde-Trapp, Marc-André Goericke, and Alexander Kempf, in a paper titled “What They Did in Their Previous Life: The Investment Value of Mutual Fund Managers’ Experience Outside the Financial Sector”.

“Our findings suggest that when managers make stock picks from their experience industries or when they time the returns of their experience industries, they perform well.”The quartet studied 130 US-based mutual fund managers. For each manager, the researchers separated out stocks related to industries in which the manager had worked, and stocks from other “non-experience industries”.

“We find that portfolios mimicking holdings from the fund managers’ experience industries earn significantly higher risk-adjusted returns than portfolios mimicking their holdings from non-experience industries,” the researchers wrote.

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The outperformance was found to range from 3% to 5% over a 12-month period, while “portfolios mimicking holdings from non-experience industries earn risk-adjusted returns that are not consistently different from zero”.

The researchers also found that managers were also better at timing investments in their experience industries. Managers increased their industry weights prior to strong returns over a subsequent 12-month period, and decreased prior to weaker performance, “in a significantly stronger fashion in their experience industries”.

The authors said this evidence “clearly documents the investment value of industry work experience”.

“However, portfolio managers are given mandates to run diversified portfolios, which might restrict their ability to utilize their prior experience to the fullest,” they wrote.

The researchers argued that fund management companies should either relax investment restrictions for some managers or “give these managers mandates to run sector funds that primarily invest in their experience industries”.

“Following such a strategy would allow these managers to make greater use of their experience in their portfolio decisions,” they concluded.

You can access the paper here.

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US Public Pension Shortfall Triples in Under a Decade

 State and municipal pension funding levels have declined rapidly since 2004. 

Funding gaps in the 25 largest US public pension sector tripled in the eight years to the end of 2012 with unfunded liabilities hitting $2 trillion, rating agency Moody’s has claimed.

In a research note, the firm claimed a focus on investment rather than contributions had left the sector in disarray.

“Employer and employee contributions are the bedrock of any defined benefit pension plan because they establish the base of assets that investments should then help expand,” said Al Medioli, a senior credit officer at Moody’s. “However, the Governmental Accounting Standards Board (GASB) pension accounting and disclosure regime emphasizes investment returns over annual contributions; the resulting funding disincentive is at the core of the public sector pension asset-liability gap.”

Moody’s claimed that even though many of the funds managed to attain their investment targets, these figures were used to calculate discount rates, which in turn pushed up liabilities.

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The average annual return in this sector over the period was 7.45%, Moody’s said, but this had not been enough to counteract losses made in the financial crisis and chronic lack of contributions.

“What went wrong that state and local governments could neither grow their plan funding nor prevent its decline?” Medioli asked in the note. “Part of the answer is the simple deferral of contributions for budgetary reasons, but the back-loading of costs through asset smoothing and 30-year amortization allowed by GASB suppresses near-term contribution increases, in many cases causing Unfunded Actuarial Accrued Liabilities to rise for years by design.”

Medioli said state and municipal governments had been permitted to use liberal return assumptions and pay less than the annual required contribution to their pension funds.

Last year, the executive director of the Teachers’ Retirement System (TRS) of the State of Illinois Dick Ingram said inadequate employer contributions had pulled the fund further into deficit. In November, the system was 40.6% funded.

“It’s important to note that the TRS 30-year rate-of-return at the end of fiscal year 2013 was 9% per year on average,” Ingram said. “Our assumed return rate of 8% also is a 30-year expectation. TRS investments over time are more than right on target.”

The problem, Ingram said, was that the contribution from the state that is required by the law was far short of the amount required to ensure long-term sustainability.

“Without changes to the pension code to ensure sustained and adequate funding, TRS faces the very real possibility that in a few decades the system will not have enough money to pay benefits to retirees,” Ingram warned.

On a more positive note, Moody’s Medioli said that strong investment returns, combined with benefit reforms and moderating wages, were beginning to ease the rate of liability growth this year—but added there was still a long way to go.

Related content: Rating Agencies Deal Fresh Blows to New Jersey, Illinois & CalSTRS Tackles the Risk of Running Out of Money

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