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Mutual Fund Ownership and Performance

Mutual Fund Ownership and Performance

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Published by Cale Smith
Conclusions from a study examining the link between portfolio managers' investments in their own funds and their returns.
Conclusions from a study examining the link between portfolio managers' investments in their own funds and their returns.

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Published by: Cale Smith on Nov 11, 2010
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01/13/2011

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PORTFOLIO MANAGER OWNERSHIPAND MUTUAL FUND PERFORMANCE
Allison L. EvansKenan-Flagler Business SchoolUniversity of North Carolina - Chapel HillEmail: allison_evans@unc.eduCurrent Draft: January, 2006ABSTRACTThis paper examines the association between a mutual fund manager’s personalfund investment and mutual fund performance. My database of newly-releasedmanagerial ownership disclosures reveals that fund ownership levels vary across mutualfund managers and, in many instances, are quite large. I find that mutual fund returns areincreasing in the level of managerial fund investment, consistent with personal ownershiprealigning decision-maker and shareholder interests. Also consistent with the reductionof agency costs of the type set forth in Dow and Gorton (1997), I find that managerialownership is inversely related to fund turnover.
I would like to thank the members of my dissertation committee for their valuable guidance and support:Douglas Shackelford (chair), Jennifer Conrad, Mark Lang, Ed Maydew, and Jana Raedy. I also appreciatehelpful comments from Courtney Edwards, Jim Irving, and Sudarshan Jayaraman. I am grateful to Lipper,Inc. for providing capital gain distribution data and to Kunal Kapoor, Director of Fund Analysis atMorningstar, Inc., for several helpful discussions.
 
 1INTRODUCTION AND MOTIVATIONThe purpose of this paper is to determine whether a fund manager’s personalownership of mutual fund shares is associated with differences in mutual fund performance. Specifically, this paper examines whether mutual funds with higher levelsof managerial ownership experience higher returns and/or lower fund turnover. Such afinding would be consistent with fund ownership reducing agency costs betweenmanagers and fund shareholders in the mutual fund industry, beyond the currentcompensation structure. Using a sample of initial ownership disclosures, I find thatmanagerial ownership is positively related to fund returns and inversely related toturnover levels.The relation between a manager’s investment in his business and the performanceof that business has generated interest across the fields of accounting, finance, andeconomics. Many papers, including Jensen and Meckling’s (1976) seminal work, haveanalyzed the effects of the separation of ownership and control, as well as compensationstructures that attempt to realign incentives between the two. Studies have examined, for instance, the effect of firm managerial ownership on dividend policy (e.g., Lambert et al.(1989); Chetty and Saez (2005); Brown et al. (2005)), inventory choices (e.g., Hunt(1985); Niehaus (1989)), investment decisions (e.g., Clinch (1991)), market valuation(e.g., Morck et al. (1988)), discretionary accounting adjustments (e.g., Warfield et al.(1995)), disclosure decisions (e.g., Aboody and Kasznik (2000); Nagar et al. (2003)), andfuture earnings (Hanlon et al. (2005)).Similar examinations of the relation between a manager’s share ownership and performance have never been attempted in the mutual fund arena because managerial
 
 2fund ownership data have been unavailable prior to 2005.
1
Since mutual fund managersare not required to own fund shares, many researchers have assumed that their investmentis small. Jin (2006), for instance, assumes that, since mutual funds managers generallyare not required to own shares in their fund, they have no personal reason to care aboutfund tax consequences. This statement implies that the lack of an explicit requirement toown fund shares is equivalent to a manager not making a material investment in his fund.This assumption, though common, is contrary to the findings in this study. Of the 237mutual fund portfolios in my sample, 22 percent have a manager who has personallyinvested over $1,000,000 in his fund.In addition to being a vehicle to extend the agency literature, mutual funds areimportant in their own right. Mutual funds are playing an increasingly large role indomestic equity markets, as documented by the Investment Company Institute (ICI,2005). The ICI reports that the mutual fund industry managed $8.1 trillion and heldapproximately 22% of the outstanding stock of US companies in 2004. At the same time,regulators and fund investors are increasing their focus on the trading behavior of fundmanagers after the revelation of several recent trading abuses. This increased scrutinyculminated in the SEC’s new regulation requiring mutual funds to disclose managerialownership levels, compensation structure, and conflicts of interest.
2
Any empirical
1
Tufano and Sevick (1997), Qian (2005), and Meschke (2005) study agency problems with respect to fund boards of directors.
2
US Securities & Exchange Commission, 2004. Final Rule: Disclosure Regarding Portfolio Managers of Registered Management Investment Companies. 17 Code of Federal Regulation Parts 239, 249, 270, 274.US Government Printing Office, Washington, DC.
3
Kunal Kapoor, Director of Fund Analysis at Morningstar, Inc., places mutual fund managers in twodistinct categories: money managers and fund shareholders. This categorization reflects the opinion thatfund managers who are personally invested in the fund likely possess more conviction, taking more care inexecuting appropriate trades, than money managers who simply perform investing services in exchange for compensation.

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