Research advises caution over fund managers who switch firms

Fund managers who switch firm or set up their own company experience a slight initial gain in performance before it peters out, according to research that challenges star stockpickers to prove their worth.

Those fund managers who transferred to a different business delivered twice the alpha — outperformance compared with a benchmark or index — in the first three years of establishing a new fund, according to data provider Morningstar.

But over five years or more, individual fund managers’ performance slid below their previous record, Morningstar said. On average they outperformed the new management on their old funds by 52 basis points each year, but this varied significantly across the sample.

“It’s very hard for fund managers to replicate their success,” said Mathieu Caquineau, director of equity research at Morningstar. He said smaller pot sizes meant managers could be agile at the start. As funds swell, liquidity requirements mean investments have to be funnelled into larger businesses.

Findings suggest investors should be cautious when deciding whether to switch funds, as personnel changes may not reflect the wider factors shaping returns.

Star stockpickers such as Terry Smith, founder of investment house Fundsmith, have proved popular among retail investors. But volatile markets have translated into big fluctuations in performance.

Caquineau said there were “few success stories” of fund managers launching their own firm and that investors should “stay on the sidelines” for a period of time to observe how a fund manager performed in a new environment. Neil Woodford, whose fund collapsed in 2019, offered the most extreme of what can go awry when investors follow a manager in a new venture.

Morningstar analysed data from open-ended equity and fixed-income funds in the US and Europe, with data from 1990 and 2002, respectively. It captured the performance of 518 fund managers who changed firm or established a new company and had at least a six-year record.

In the first three years at a new firm, fund managers on average returned an alpha of 1.36 per cent, compared with 0.67 per cent at their old firm over the same period. Morningstar said the top quartile returned 2.85 per cent in alpha, though the bottom quartile underperformed by some 53 basis points.

Analysts also said that two in five fund managers who switched to a rival had produced a negative alpha in the three years leading up to their departure. It said this could be partly attributed to longer-term performance and a manager’s philosophy falling out of fashion.

“It’s very difficult to make any statistical inference about whether the underlying fund manager is having an impact on performance,” said Mick Gilligan, head of managed portfolio services at wealth manager Killik & Co. He said that investors should look out for any radical departure in investment styles.

Investors should read a fund’s reports to ensure it had not radically overhauled its approach, Gilligan added. This could be more concerning than a change in fund manager, with some changing tack only to be stung by market shifts.

Caquineau said: “A criteria for investors is looking at how firms have integrated new fund managers in the past, and how well have they been able to handle [their] integration.”

Morningstar’s research did not capture fees, which vary between firms and could eat into any returns. Rob Burgeman, an investment manager at RBC Brewin Dolphin, said: “Some people leave an existing firm to go and join another where the fee structure means they’re going to make more.”

Burgeman said that charges could mask performance fees, which he said were “occasionally warranted, but often they’re not”.