What is the Attraction of Star Fund Managers?

In sport, when an individual has a spell of sustained success and dominance they tend to enjoy widespread support; think of the likes of Roger Federer, Tiger Woods or Usain Bolt.  Although there are exceptions, people tend to want their runs of glory to continue.  But when it comes to a team, the reverse is often true.  Rarely does anybody but  the fans of the New England Patriots or Manchester United want them to win. This contrast has been highlighted in a recent paper by Jesse Walker and Thomas Gilovich[i], and they call this preference for continued strong performance from individuals over teams ‘the streaking star effect’.  It is a phenomenon we can also observe in the investment industry, where we are often in thrall to the successes of a star fund manager.

Walker and Gilovich carried out a number of tests to observe people’s preference for the continued success of an individual rather than a team.  In a study, participants were told about awards given by the National Association of Police Organizations. In one scenario an individual won ‘Best Homicide Detective’ four years in a row; in another Kansas City or LAPD won ‘Best Homicide Department’ in four consecutive years.  Participants had a significant partiality for the individual detective continuing his success over the departments. They also felt more ‘wonder’ and positivity regarding their achievements.

Even when Walker and Gilovich tested their hypothesis using trivial or arcane events – such as the British Quizzing Championship or the Italian game Calcio Fiorentino – participants continued to prefer individual success to that of a team.

In another study, people also felt that companies were ‘deserving’ of a greater market share if their success was framed as being as a result of individual brilliance of a CEO as opposed to a group effort.  This feels intuitive, and it is easy to think of a number of contemporary examples of this.  

What is driving this phenomenon? Walker and Gilovich acknowledge that is could be a variant of the ‘Identifiable Victim Effect’, where we are more likely to identify with and offer assistance to a specific individual, rather than a generic group. They label this ‘Identifiable Victor Effect’.  Yet they suggest another driver – that we experience a greater sense of awe when witnessing individual achievements.

When we see persistent, individual success the responsibility and credit is clear – it belongs to them – and we enjoy seeing exceptional people pushing the boundaries of possibility.  Furthermore, individual brilliance is fleeting and rare.  When we attribute glory to the talent and ability of an individual by definition it cannot persist indefinitely.  When it is a team or a group the success could be perpetual, and it is far more opaque and difficult to define.  The story is harder to write.

Individual success is clear, comes with just rewards and is deserving of wonder. Group success can be overbearing, unfair and with no natural end.

Our fascination with star fund managers is inevitably linked to some of the issues raised by Walker and Gilovich.  We laud and participate in the success of such managers (while it lasts), but seem far more likely to view the achievements of teams or firms with some level of scepticism and mistrust.

This creates something of a quandary for asset management firms.  Star fund managers can do an incredible job of raising assets and are perhaps the most effective single marketing tool used to draw in investors. Team or firm-based approaches don’t have the same appeal, but do insulate a business against the loss or failure of any particular individual. 

Being attracted to individual success stories also leaves investors vulnerable. Whilst we know that Rafael Nadal’s success  is largely a result of application and skill; there is too much randomness in financial markets for us to unequivocally know that a streak is not just a run of good fortune. Even if a fund manager is skilful, the power of the narrative around them often leads us to make imprudent decisions.   It is never a sensible idea to make investment decisions based on our admiration of an individual or our desire to participate in their story.

The lesson for investors is to be aware of the strong lure of streaking star fund managers, who catch the eye but so often burn out.  We need to spend less time thinking about any given ‘exceptional’ individual, and instead concentrate on our own objectives and the overall outcomes we want to achieve.

[i] Walker, J., & Gilovich, T. (2020). The streaking star effect: Why people want superior performance by individuals to continue more than identical performance by groups. Journal of Personality and Social Psychology.

A Fund Manager’s Time Horizon is the Shortest Common Denominator

For most fund managers there is nothing more important than adopting a long-term approach.  This enables them to insulate themselves from the noise and random fluctuations of financial markets, and hopefully exploit them.  Yet for many this is simply not possible. Perverse and misaligned incentives, the desire to measure everything over meaningless time periods and the ascendancy of outcomes over process mean that the long-term is nothing more than a collection of reporting months and quarters.  Even when a fund manager’s express intention is to operate with a long time horizon, often they cannot because it is decided by the behaviour of other people. They don’t get to choose.

Every investment strategy or fund has a chain of involvement.  This will range from the underlying clients, to the fund managers, risk teams, CIOs and even CEOs.  All have differing objectives, incentives and levels of influence.  Unless all parties involved are aligned, the actual investment time horizon may not be what is stated in the investment philosophy, but be set by the shortest common denominator.  That is the shortest time horizon of someone involved who holds influence. 

If investors have the ability to freely withdraw money from a fund and are focused on monthly performance figures, then the fact that the investment approach is designed to take a five year view becomes almost an irrelevance.  Short-term numbers matter. Equally, if the CEO of a listed asset manager is worried about near term outflows then performance over the next quarter is everything.  In both of these cases the power lies away from the fund manager.  The client has the ability to sell their fund; the CEO has the ability to sack them.

When short-termism arises in the chain it becomes highly infectious. It affects the behaviour of everyone involved, most importantly the fund manager.  Their behaviour will either consciously or subconsciously change to stave off career risk.  The typical route to this is by chasing momentum.  Buying what has worked recently is an easy way to please everyone in the chain, for that moment at least.

It is not that investors (whose money it is) and senior managers should not have influence or choice, but it is crucial to acknowledge the impact that this may have on the ability of a fund manager to stick with their investing disciplines. It is not easy making long-term decisions when everyone will be poring over the next set of performance figures.  As soon as all involved in the chain have defaulted to a short-term view the investment outcomes become captured by randomness. Success or failure is no longer about the validity of an investment approach, it is about the toss of a coin.

How much influence other people possess in a chain relative to a fund manager will be heavily dependent on past performance. A fund manager with strong historic results will have more influence – they have pedigree and a track record. They are at little risk of outflows or redundancy so can set the terms. As performance deteriorates this changes.  The manager becomes more vulnerable and the influence shifts. Without a track record to fall back on they are at the mercy of others, often with interests and incentives that are based on a horizon very different to what appears in a due diligence document. 

When we consider a fund manager’s investment time horizon we often focus on how they apply their philosophy and process; with maybe some consideration as to whether their incentive package is aligned with this, But that is not sufficient. The crucial issue is whether a fund manager operates in an environment where they are able to invest with a sufficiently long time horizon.  Who are the other people with potential influence over the strategy and what are their incentives? This is difficult to answer and will evolve, but is vital for understanding on what basis investment decisions are actually being made. 

Investment strategies with fixed capital or fixed terms partially overcome this problem as their illiquidity forces a level of alignment; but the real benefit is for private investors.  Private investors don’t have a chain of involvement; they have one time horizon and one objective – their own. They can make decisions free of competing interests and conflicted incentives. It is easy to underestimate the incredible advantage this offers in reaping the benefits of making genuinely long-term decisions. 

So many professional fund managers extol the virtues of adopting a long-term approach, but how many are in a position or environment  that allows their words to be validated by their actions?  The structure of influence and incentives within the industry make it increasingly difficult to achieve.