Are there differences in performance between fund managers depending on the wealth of their families?
What are the possible channels that may contribute to the performance gap?
Is the underperformance of managers coming from a wealthy family due to market timing or security selection?
Do mutual fund companies derive nonperformance beneﬁts from employing managers from wealthy families?
What are the Academic Insights?
By using a number of datasets (Morningstar U.S.-domiciled mutual funds, Factset, the Nelson’s Directory of Investment Managers, the National Student Clearinghouse, the College Handbook of the College Entrance Examination Board, the Lexis Nexis Public Records, and the Federal Census), the authors find the following:
YES- the authors find that fund managers from wealthy families underperform managers from poor families. For example, managers from families in the top quintile of wealth underperform managers in the bottom quintile by up to 1.36% per year (signiﬁcant at 1%) on the basis of the four-factor gross alpha. Similar results hold for alternative measures of performance, such as benchmark-adjusted fund returns and the dollar value extracted from capital markets.
The authors explore two channels: a) effort and b) ability. The ﬁrst channel posits that managers from poorer families exert more effort because they obtain higher marginal utility from incentive pay under the assumption of a declining marginal utility of wealth. The second channel posits that managers from poorer backgrounds have a higher innate ability, since only high-ability managers are able to overcome stringent selection.
The relative underperformance of the managers from wealthy families is concentrated in security selection. An interquartile range decrease in family wealth improves the stock-picking component of fund returns by 39% relative to its sample mean. There is no difference in the market timing component of returns.
The authors do not ﬁnd reliable evidence of such beneﬁts. In particular, neither capital ﬂows nor management fees are signiﬁcantly higher for funds run by wealthy managers. This result points to possible agency problems or frictions in the asset management industry that require further research.
Why does it matter?
This paper provides evidence that public information about a manager’s family descent serves as a powerful signal of managerial ability in professions with high barriers to entry, like the asset management industry.
The Most Important Chart from the Paper
Table 3, panel A, reports the estimation results, beginning with speciﬁcations without manager controls (Columns 1 and 6) and gradually adding controls for manager characteristics correlated with wealth. Both measures of wealth are reliably negatively related to alpha, and this relation becomes stronger and economically larger as controls for manager characteristics are added. This pattern is consistent with the predictions of the model.
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index.
Using data from individual Census records on the wealth of managers’ parents, we find that mutual fund managers from poor families outperform managers from rich families. We argue that managers born poor face higher entry barriers into asset management. Consistent with this view, managers born poor are promoted only if they outperform while those born rich are more likely to be promoted for reasons unrelated to performance. Overall, we establish a first link between fund managers’ family descent and their ability to create value.
After serving as a Captain in the United States Marine Corps, Dr. Gray earned an MBA and a PhD in finance from the University of Chicago where he studied under Nobel Prize Winner Eugene Fama. Next, Wes took an academic job in his wife’s hometown of Philadelphia and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management firm dedicated to an impact mission of empowering investors through education. He is a contributor to multiple industry publications and regularly speaks to professional investor groups across the country. Wes has published multiple academic papers and four books, including Embedded (Naval Institute Press, 2009), Quantitative Value (Wiley, 2012), DIY Financial Advisor (Wiley, 2015), and Quantitative Momentum (Wiley, 2016).
Dr. Gray currently resides in Palmas Del Mar Puerto Rico with his wife and three children. He recently finished the Leadville 100 ultramarathon race and promises to make better life decisions in the future.
Performance figures contained herein are hypothetical, unaudited and prepared by Alpha Architect, LLC; hypothetical results are intended for illustrative purposes only. Past performance is not indicative of future results, which may vary. There is a risk of substantial loss associated with trading stocks, commodities, futures, options and other financial instruments. Full disclosures here.