Tailored versus Mass Produced: Portfolio Managers Concurrently Managing Separately Managed Accounts and Mutual Funds

Published date01 November 2017
Date01 November 2017
The Financial Review 52 (2017) 531–561
Tailored versus Mass Produced: Portfolio
Managers Concurrently Managing
Separately Managed Accounts and Mutual
Fan Chen
Merrimack College
Li-Wen Chen
Hardy Johnson and Sabuhi Sardarli
Kansas State University
Using a matched sample of separately managed accounts (SMAs) and mutual funds (MFs)
with the same portfolio manager and investment style, we findthat concurrently managed MFs
consistently underperform their SMA counterparts and generate more negative return gaps.
Fund characteristics and liquidity betas fail to fully explain the underperformance. An event-
study analysis finds that the weights placed into top (bottom)-performing stocks increase
for existing SMAs (MFs) and negative return gaps increase for the MFs after the onset of
concurrent management. We find that higher compensation collected by SMA fund managers
are associated with more unseen managerial actions which positively contribute to the SMA
Corresponding author: Merrimack College, Girard School of Business, 315 Turnpike Street, North
Andover, MA 01845; Phone: (978) 837–5058; E-mail: chenf@merrimack.edu.
The authors thank SrinivasanKrishnamurthy (the editor), Robert Van Ness (the former editor), Bonnie Van
Ness (the former editor), three anonymous referees, the seminar participants at University of Mississippi,
University of Memphis, Sacred Heart University,National Central University, National YunlinUniversity
of Science and Technology,and the 2011 FMA annual meeting for comments and suggestions. Inaccuracies
that may have been introduced in subsequent revisions are the sole responsibility of the authors.
C2017 The Eastern Finance Association 531
532 F. C h e n et al./The Financial Review 52 (2017) 531–561
return gap. Our results suggest that when managers concurrently manage both SMAs and MFs,
they favor SMA performance over their MF performance.
Keywords: separately managed account, mutual funds, concurrent management,
JEL Classifications: G20, G23, G24, G29
1. Introduction
For institutional investorsand qualified individual investors, separately managed
accounts (SMAs) are an alternative investmentvehicle to mutual funds (MFs). These
two investment options are similar in that a professional manager is in chargeof mak-
ing investment decisions on behalf of their clients while receivingcompensation from
managing fund assets. Although MF clients’ investable assets are pooled, in SMA
arrangements the portfolio manager buys securities on behalf of the client and places
them in an account directly owned by the client. Many financial institutions offer
both types of these funds for their qualified clients as the managerial skill required
for these funds are transferable.1We examine whether performance of SMAs and
MFs by the same fund manager differs.2Our second purpose is to identify potential
reasons for this performance difference, should we find that the difference exists.
To answer these questions, we analyze investment managers who concurrently
control at least one SMA and one MF with the same investment strategy. Previous
studies that have analyzed the performance of SMAs and MFs have not effectively
controlled for managerial skill because those studies typically have matched funds at
the managing firm level. Our pairing methodology at the fund manager level allows
us to control for managerial skill, in addition to any firm-level effects.
A single manager in charge of both types of funds has an interest to have both
funds perform well and would be expected to make similar investment decisions for
both types, should the fund styles and strategies be identical. In fact, we find that on
average, 75% of the fund holdings of SMAs and MFs that are managed by the same
fund manager are identical. However,a manager has higher incentive to have a better
performing SMA rather than a better performing MF. The first incentive arises from
the relative size of SMAs as compared to MFs. In our paired sample of concurrently
managed funds, an average SMA is almost three times larger than an average MF.
In addition, management fees (as a percent of assets under management) charged
by SMAs are usually higher than those by MFs. Therefore, concurrent managers are
1Throughout this study, we loosely refer to both SMAs and MFs as “funds” because they are different
types of investment funds offered by financialinstitutions.
2The Wall Street Journal (“SMAs beat funds in 2008”; Salisbury, 2009) and Morningstar report SMAs
outperform MFs. Morningstar also reports that SMAs outperformed MFs in 25 of 36 stock and bond
markets in 2008 and outperformed in 22 of 26 categories from 2005 to 2008.

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