Mutual Fund Managers’ Prior Work Experience and Their Investment Skill

• DOI: http://doi.org/10.1111/fima.12180
• Author: Rui Chen,Zhennan Gao,Xueyong Zhang,Min Zhu
• Date: 01 March 2018
• Published date: 01 March 2018

Mutual Fund Managers’ Prior Work

Experience and Their Investment Skill

Rui Chen, Zhennan Gao, Xueyong Zhang, and Min Zhu∗

This paper examines the relationship between mutual fund managers’ past professional back-

grounds and their portfolio performance using Chinese mutual fund data from2003 to 2016. We

focus on managers with prior workexperience either as industry analysts or as macroanalysts. We

hypothesize that managers who worked as industry analystsexhibit superior stock picking skills,

while managers with a background as macroanalysts time the market better. These hypotheses

are supported by the data after controlling for observable fund and manager characteristics.

Bootstrap analyses suggest that a significant difference in performance between these two types

of managers cannot be attributed purely to luck.

An active manager can add value by deviating from their benchmark index in one of two

ways: stock selection or market timing. Stock selection, or stock picking, places active bets on

individual stocks (e.g., selecting underpriced stocks). Market timing involves dynamic betting on

broad economic factors, such as overweighting particular sectors of the economy. Stock selection

is a bottom-up approach, requiring thorough research on individual firms’ business models

and the value of their stock. Alternatively, market timing is a top-down approach to portfolio

construction. Managers engaging in market timing presumably have a superior ability to process

macroeconomic data so as to produce accurate forecasting. These two kinds of value-adding

activities require different skill sets, and it is highly plausible that some fund managers excel in

one skill more than the other.

Human capital is the stock of knowledge, habits, and social and personality attributes embodied

in an individual’s ability to produce economic value. The theory of human capital holds that

greater human capital can transform into greater productivity. In the mutual fund literature, a

number of studies have investigated the effects of mutual fund managers’ characteristics on

their portfolio performance. Golec (1996) relates portfolio performance, risk, and fees to fund

managers’ characteristics, such as age, tenure, and education. Gottesman and Morey (2006)

examine the influence of manager education and conclude that education is a pertinent factor in

performance. Cohen, Frazzini, and Malloy (2008) find that fund managers with past educational

ties to corporate board members outperform in the stocks of those corporations, suggesting

that social networks can aid in the transfer of private information. Sonney (2009) confirms that

European sell-side analysts with a country specialization outperform analysts with an industry

We are grateful to the Marc Lipson (Editor) and an anonymous referee. We thank discussants of workshops hosted by

the China Young Finance Scholars Society. Xueyong Zhang acknowledges financial support from the National Natural

Science Foundation of China (71673318,71602198), a program for innovation research and a program for excellent

academic talents of the Central University of Financeand Economics. Rui Chen acknowledges financial support from the

National Natural Science Foundationof China (71403306), a program for innovation research of the Central University

of Finance and Economics. All errorsare our own.

∗Rui Chen is an Assistant Professor in the School of Finance at the Central University of Finance and Economics in

Beijing, China. Zhennan Gao is a Ph.D. student in the School of Economics at Peking University in Beijing, China.

Xueyong Zhang is a Professor in the School of Financeat the Central University of Finance and Economics in Beijing,

China. Min Zhu is a Lecturer in the Business Schoolat Queensland University of Technology in Brisbane, QLD, Australia.

Financial Management •Spring 2018 •pages 3 – 24

4Financial Management rSpring 2018

specialization indicating that an understanding of local product markets is crucial to analyzing

stock valuation.

Webelieve that a fund manager’scareer path and training play an important role in the formation

of human capital. Human capital, in turn, impacts the manager’s portfolio strategies and styles.

In particular, we focus on two types of professional background of mutual fund managers: 1) in-

dustry analysts and 2) macroanalysts. Industry analysts are responsible for companies belonging

to a certain industry sector, such as telecommunications or tourism, and possess a specialized

knowledge of a large body of individual companies. In addition, as part of their investigations

into individual firms, industry analysts build close relationships with the corporate managers in

those firms. This detailed knowledge about individual companies and the social connection with

corporate managers give fund managers with a background as industry analysts the edge in pro-

cessing firm-level information. Meanwhile, the primary mission of a macroanalyst is to analyze

and forecast government policy and macroeconomic trends affecting the market. A successful

macroanalyst is one who has a greater understanding of the overall risk factors and possesses a

superior ability to forecast macroeconomic trends. Close relationships with government officials

developed over a period of years are also likely to contribute to the information advantage of

managers who worked as macroanalysts. All of these characteristics of a fund manager with a

macroanalyst background contribute to enhanced market timing skills.

In this study, we hypothesize that fund managers with different professional backgrounds

possess different investment skills. In particular, managers whoworked as industry analysts have

superior stock picking skills, while managers who worked as macroanalysts are better at timing

the market. We test these hypotheses using a sample of Chinese mutual fund managers who had

previously worked either as industry analysts or macroanalysts.

Chinese mutual fund data provide us with several advantages. First, Chinese mutual funds are

largely managed by solo managers. Over 70% of funds are of single management currently.1

This is opposite of the trend in the United States where team management has become the

dominant management structure in the mutual fund industry. Studies by Wang (2016) and Patel

and Sarkinssian (2017) find that more than 70% of US domestic equity mutual funds have been

team managed in recent years. We are interested in the influence of fund managers’ human

capital on their investment skills on an individual level. Thus, Chinese mutual fund data serve

our purpose well. In addition, when compared with a mature market, such as the US market,

the Chinese market is quite volatile and experiences frequent sharp rises and declines with

monthly stock market volatility reaching 9.65% compared to 4.45% on the S&P 500 from 1996

to 2015 (Chen et al., 2016). This particular market environment provides a level playing field

for both stock pickers and market timers. In a market with low volatility, market timers are at a

disadvantage as their skills are not rewarded. As a result, managers may appear to be unskilled

for reasons unrelated to their actual skills. We demonstrate that this is not a concern for our study

in a later section as both stock picking and market timing are equally rewarding in the Chinese

market. Moreover, Chinese mutual fund data present minimal survivorship bias. The Chinese

mutual fund industry has enjoyed rapid growth in the past two decades, and it is rare that a fund

ceases operation.

Using the two classic modeling frameworks, Treynor and Mazuy (1966) and Henriksson and

Merton (1981), we decompose abnormal fund returns into two parts: stock picking and market

timing. Toaccess the statistical signif icance of the investmentskills, we apply a bootstrap analysis

by Cao et al. (2013). We find that managers with industry analyst experience exhibit superior

1Based on our calculations, the proportions of single managed funds in Chinese mutual funds in recent years are 75% in

2012, 73% in 2013, 74% in 2014, and 69% in 2015.