THE PERFORMANCE PERSISTENCE OF WINNER FUND MANAGERS – EVIDENCE FROM THE TIMING AND STOCK PICKING ABILITY

Ying-Fen Fu¹ --- Hai-Ching Liu²⁺

¹Assistant Professor, Department of Finance, Tainan University of Technology,Taiwan

²Assistant Professor, Department of Finance, Southern Taiwan University of Science and Technology,Taiwan

Keywords : Fund manager, Timing, Stock picking, Performance persistence, Winner, Equity funds.

Article History : Received: 18January 2017, Revised: 22March 2017, Accepted: 5April 2017, Published: 24April 2017

JEL Classification : G10, G11.

1. INTRODUCTION

Mutual funds with good performance always attract the attention of investors. And there is no lack of media coverage regarding fund managers with excellent management ability. In fact, the excellent management skill may come from multiple sources, including the timing and stock picking ability (Grinblatt and Titman, 1993; Daniel et al., 1997). The timing ability denotes that fund managers can raise or reduce the holding positions at the right time, and the stock picking ability represents that fund managers can buy the stocks with following good performance and sell those with following bad performance.

This study aims to investigate whether the winner fund managers (with performance in top 20%) has the persistent timing and stock picking ability regarding the previous and subsequent funds which they manage. Winner fund managers tend to be headhunted by other funds due to their excellent performance. However, whether the excellent timing and stock picking ability of winner managers are persistent needs more investigation. Kacperczyk et al. (2014) point out thatalthough not all fundsperformwell, some excellent fund managers indeedcanprovidevaluable service for theircustomers if ignoring the fee. Thusit’s an interesting issue to investigatewhether the theprevious and nextfundswhich winner managers manage are timing and stock picking persistent. This studyfocuses on the persistence of timing and stock picking ability of ‘fund managers’ ratherthan ‘funds’, so the samplewouldbe the fundswhichweremanaged by the samefund managers in the previous and subsequentperiods.

This study fills the gap of literature by focusing on the timing and stock picking ability of “fund managers” rather than on those of “funds”. This study will clarify whether the outstanding timing and stock picking ability of fund managers persists when they manage another fund. Little literature investigates issues regarding the fund managers in Taiwan. The results of this study may provide important reference for fund investors when they are making investing decisions.

2. LITERATURE REVIEW

The management ability of fund managers can be measured through timing and stock picking ability. The timing ability denotes the fund managers may increase β of their portfolios when the market index is rising, and vice versa. Fund managers with timing ability may hold more risky positions when the market is in bull market, while they may hold less risky positions when the trend of market goes down (Kacperczyk et al., 2014). The stock picking ability measures the abnormal return which is the return between the selected stocks and the benchmark. Fund managers with stock picking ability may choose stocks with better subsequent performance (Fulkerson, 2013).

Past literature demonstrates that fund managers cannot perform better than the passive strategy if assessing their management ability by performance (Fama and French, 2010). However, some researches denote that some funds can perform well persistently (Kacperczyk et al., 2005;2008; Christoffersen et al., 2007; Kacperczyk and Seru, 2007; Cremers and Petajisto, 2009; Baker et al., 2010; Cohen et al., 2011; Huang et al., 2011; Amihud and Goyenko, 2013; Koijen, 2014). The consistent result of the literature points out some of the best fund managers have stocking picking ability, but they almost have no timing ability(Ferson and Schadt, 1996; Graham and Harvey, 1996; Daniel et al., 1997; Becker et al., 1999; Kacperczyk and Seru, 2007). A skilledfund manager willtry to earnhigherexpectedreturns by raising the weight of stocks which are expected to performbetter in their portfolio. However, Daniel et al. (1997) do not observe the timing ability of fund managers. Daniel et al. (1997) and Wermers (2000) point out thatfund managers do not have timing abilitywhenconsidering the stock characters, includingmarket value, the ratio of market value over book value and momentum. Theydiscover the positive stock picking ability but no timing ability. Although the aboveliterature shows little timing ability of fund managers, Bollen and Busse (2001) and Elton et al. (2012)find the timing ability of fund managers whenadopting the higherfrequency data. Kacperczyk et al. (2014)demonstratethat the management skills of fund mangers differbetween bull and bearmarkets. They observe the top 25% winner fundswith stock picking ability in booms. And theyfindthatthesefunds have significant timing ability in recessions. That is, fund managers time the marketwell in recessions, whiletheypick stocks well in expansions.

Regarding the stock picking ability, Fama and French (2010)findthat few fundscan beat the passive benchmark effectively, indicating the weakskill of fund managers. However, Kosowski et al. (2006) point out thatsomefund managers have the ability of stock picking. For thesefund managers, the excellent stock picking abilitywillmake up for the cost, making the performance persistent. Grinblatt and Titman (1989;1993)and Wermers (1997)concludethat the active fund managers canpick the stocks significantlywell. Wermers (2000)furtherinvestigating the American mutualfundsin 1975~1994 findthat the return of funds’ holdings are 1.3% higherthanmarket index, 0.7% comingfrom stock picking ability and 0.6% comingfrom the characteristic of funds’ holdings. Kacperczyk et al. (2005) and Wermers (2000) find that the turnover rate and abnormal return are positively related. Wermers believe that fund managers adjust their portfolio according to the new information and result in the excellent stock picking ability.Kosowski et al. (2006)adopting the bootstrapanalysis displays that star fund managers’ stock picking abilityis good enough to cover the cost. Kacperczyk et al. (2014)findthat the the top 25% winner fundswith timing ability in recessionscansignificantlypicks stocks well in booms. Kacperczyk et. al.,demonstratesthatonlysomefund managers have the management skill. And how to make use of the skillsdepends on the econmicenvironment. Although the skilledfund managers can carry out theirtasksucessfully, it more or lessdepens on the environment of the market. Fulkerson (2013)investigating the equityfunds in Americafindthatfund managers have the stock picking ability in the first period (1980-1994), whilethey do not have the stock picking ability in the second period (1995-2007). Fulkersonbelievesthat the stock picking in the mutualfundindustryis the main sources of managers’ skills.

The excellent fund managers must have the outstanding management skills. The literaturedemonstratesthat the skillmay come from the excellent stock picking or timing ability. Kacperczyk et al. (2014)findthat good fund managers have the stock picking ability in booms and the timing ability in recessions. The fund managers with stock picking ability in expansion can do the timing well in recessions. Thesefund managers performsignificantlybetterthanotherfund managers and the performance index. Kacperczyk et al.,yet point out thatsomefund managers have the timing ability and some have the stocking picking ability. No one canperformwellboth in timing and stock picking. Kosowski et al. (2006)demonstratethat the best fund managers cannotcontributetheir performance totally to the luck. Thus, thisstudywill examine whether the management ability of the samefund managers especially the excellent fund mangers persists. Moreover, thisstudywillinvestigatewhether the persistencecomesfrom the timing abilitypersistenceor the stock picking abilitypersistence.

This studyfocuses on the winner fund managers. The media reports these excellent fund mangers more oftenthanother managers. Therefore, the excelelntfund mangers canattrack more attention of fundinvestors. This studyaims to investigate the persistence of fund managers’ timing and stock picking ability, whichwill help investorsclarifywhetherfollow the excellent fund managers is a good decision or not.

3. RESEARCH METHOD

3.1. The Data

The sample of thisresearchis the equityfunds in Taiwan. The sampleperiodisfrom Jan. 1997 to Dec. 2012. This studyinvestigatesprevious and nextequityfundswhich the samefund managers manage. The data of fund managers and the fundsthey manage wascollectedfromFund DJ website. FollowingBrinson et al. (1986) and Brinson et al. (1991)wemeasure the timing and stock picking ability of fund managers for the periodthey manage the specificfund. When the ranking of the timing (stock selecting) ability of the fundis in top 20%, the fund manager who manage thisfundisdenoted as winner fund manager. The data of fundexpense ratio (Carhart, 1997) turnover rate (Jan and Hung, 2003) net assets(Berk and Green, 2004; Chen et al., 2004; Yan, 2008) and fundflowswerecollectedfrom the funddatabase of TEJ (Taiwan Economic Journal).

3.2.ResearchMethod

This studyaims to investigatewhether the timing and stock picking ability of previous and nextfundswhich winner fund managers manage are persistent. The definition of timing and stock picking abilityis as follows :

3.2.1.The Definition of Timing and Stock Picking Ability

Regarding the timing and stock picking ability, thisstudyadopts the definition of Brinson et al. (1986) and Brinson et al. (1991). Theydivideabnormal performance into timing ablility, stock picking ability and others. The abnormalperfromanceis the sum of the threefactors. The definition of abnormal return is the differencebetween the fund return and the poilcy return (passive basic holdings). The holdings of equityfunds in Taiwan are at least 70% according to the regulation of Financial Superviosory Commission R.O.C..Therefore, 70% of holdings is the passive basic holdings. The market return is the benchmark of the passive holdings. Thus, the policy return of fundsis 70% of the market return. The definition of timing and stock picking abilityis as Table 1 :

Table-1. The Definition of Timing and Stock Picking Ability

Source:Brinson et al. (1986)andBrinson et al. (1991)

3.3. The Timing and Stock Picking Ability of Previous and NextFundswhichFund Managers Manage

Puetz and Ruenzi (2011)havepointed out thatfund managers care more about their performance rankingratherthan the absolute performance. This studyinvestigates the timing and stock picking abiltypersistence of winner fund managers, whichfocuses on the relative return not the absolute return. Following the rankingapproach of Puetz and Ruenzi (2011), this study constructs the timing and stock picking ability ranks of fund managers based on the funds they manage for the management period. The rank is between 1 and 0. The worst ranks 0 and the best ranks 1. The model is as follows:

(1)

Wherethe dependent variable ARANK_j,kdenotes the timing (stock picking) ability ranking of the next fund which the winner fund manager k manages. BRANK_i,krepresents the timing (stock picking) ability ranking of the previous fund which the winner fund manager k manages. When b₁ is significantly positive, it means the timing and stock picking ability of the previous and next funds which fund manager k manages are persistent. The control variable D_SEX equal to 1 denotes the male winner fund manager and D_EDU equal to 1 denotes that the winner fund managers’ educational background is Master or Doctor. FLOW_j,kdenotes the average net flow rate of fund j (previous fund) which winner fund manager k manages for the management period. EXP_j,krepresents the average expense ratio of fund j which winner fund manager k manages for the management period. TURN_j,kdenotes the average turnover rate of fund j which winner fund manager k manages for the management period. SIZE_j,kdenotes the average logarithmic value of fund net assets of fund j which winner fund manager k manages for the management period.

3.4.Robustness Test

This studyadopts the logisticregression as the robustness test. Model (2) aims to investigate the probability of becoming timing (stock picking) winners (1~0.8) of the nextfundswhich winner fund manager k manages if the previousfundsthey manage were timing (stock picking) winners. In Model (2), D_BWINik =1denotes the previousfundwhich the fund manager manages is timing (stock picking) winner. The logitL_j(=ln[(P_j/(1-P_j)]) is log of odd ratio –the ratio between the probability that the next fund is timing (stock picking) winner and the probability that the next fund is not timing (stock picking) winner. The higher coefficient of b₁denotes the higherprobability of becoming timing (stock picking) winners of the nextfundswhen the previousfunds the fund managers manage were timing (stock picking) winners.

(2)

4. EMPIRICAL RESULTS

4.1. The Timing and Stock Picking AbilityPersistence of Winner Fund Managers

This studyfocuses on the performance (timing and stock picking) persistence of the previous and nextfundswhich the fund managers manage. Table 2 demonstrates the PR (percentile rank) value of the previous and nextfundswhich the fund managers manage. The statistics of Table 2 shows that the performance (return, timing ability, stock picking ability and others) PR value of the nextfundswhich the fund manager manage ismostlylowerthanthat of the previousfunds. It isobviousthatfund managers performworseafterthey manage anotherfund. Table 2 furtherdividesfundsintotwo groups based on whether the previous and nextfundswhich the fund managers manage belonge to the samefundcompany or not. Regarding the managers who change jobs to the otherfundcompanies, the PR value of previousfundswhichthey manage isaboveaverage (exceeding PR 50), whichisbetterthanthat (lessthan PR 50) of the fund managers whostayat the samefundcompanies. Moreover, the retun and stock picking abilty of the nextfundswhich the fund manager who change jobs to the otherfundcompanies manages are betterthanthose of the fund managers whostayat the samecompanies.

Table 3 demonstrates the ratio of becoming winners of the next funds which the winner fund managers manage. If we define top 20% of performance as winners, the winner ratio in our sample should be 20%. The higher (lower) ratio than 20% means the fund managers in our sample perform better (worse) than the average. In addition to the whole sample, in Table 3, we also dividefundsintotwo groups based on whether the previous and nextfundswhich the fund managers manage belong to the samefundcompany or not. Regarding the statistics of the wholesample, Table 3 shows that the ratio of return and timing winner fund managers continuing to be the winners ishigherthan the average. The ratio of becoming winners of the nextfundswhich the winner fund managers who change jobs to the othercompany manage ishigherthan the average (20%), while the ratio ismostlylowerthan the average (20%) (except for the timing ability) for the thenextfundswhich the winner fund managers whostayat the samefundcompany. Generally, except for timing ability, winner managers who change jobs to the otherfundcompaniesseems to performbetterthanthosewhostayat the samefundcompanies.

Table-2. The Performance PR (Percentile Rank) Value of the Previous and NextFunds

Source:Taiwan Economic Journal and Fund DJ

Table-3. The Ratio of Becoming Winners of the Next Funds

Source:Taiwan Economic Journal and Fund DJ

Table 4 aims to investigate the persistence of performance, timing ability and stock picking ability of fund managers by observing the previous and next funds the fund managers manage. The sample of Table 4 is the funds managed by the whole fund managers. The coefficients of BRANK in Models 1 and 3 are significantly positive, indicting the return and stock picking ability persistence of the previous and next funds. However, the statistics in Model 2 shows that the timing ability of fund managers are not persistent. It is noteworthy that the coefficient of FLOW in Model 2 is significantly negative.Edelen (1999);Green and Hodges (2002);Rakowski (2003) suggest that the variation of fund flows raises the cost of managing the funds. The result of our study supports this point. Too many inflows interrupt the timing plan of fund managers because they should invest securities to the minimum requirement of 70%. The coefficient of D_EDU in Model 3 is significantly positive, which is consistent with Golec (1996). Golec (1996) finds better performance of fund managers with MBA degree, indicating the better stock picking ability of fund managers with higher educational background.

In Table 5, we dividefundsintotwo groups based on whether the previous and nextfundswhich the fund managers manage belong to the samefundcompany or not. The statistics shows that the two coefficients of BRANK in Model 3 are significantly positive, whichindicatesthat the stock picking ability of the twofundswhich the fund managers manage are persistent no matter the fund managers change their jobs to the otherfundcompany or not. Fund managers are timing ability persistent when the succesivefundsthey manage belong to the samefundcompany, whilethey are return persistent when the twofundsthey manage do not belong to the samefundcompany.

Table-4. The Persistence of Fund Return, Timing Ability and Stock Picking Ability of the Successive Funds Which Fund Managers Manage

Note: The statistics in the parentheses is t value.* significant at 0.10 level, **significant at 0.05 level, ***significant at 0.01 level.

Table-5. The Persistence of Fund Return, Timing Ability and Stock Picking Ability of the Successive Funds which Fund Managers Manage (change jobs to the other fund company or not)

Note: The statistics in the parentheses is t value.* significant at 0.10 level, **significant at 0.05 level, ***significant at 0.01 level.

Table 6 investigates the persistence of return, timing ability and stock picking ability of the two successive funds which the winner fund managers manage. The striking results are the insignificant coefficients of BRANK, which indicates that the winner fund managers are not performance (return, timing ability and stock picking ability) persistent.

Table-6. The Persistence of Returns, Timing Ability, Stock Picking Ability of Winner Fund Managers

Note: The statistics in the parentheses is t value.* significant at 0.10 level, **significant at 0.05 level, ***significant at 0.01 level.

Porter and Trifts (2012) demonstrate that although the well-performing fund managers have fine reputation, they cannot keep their excellent performance. The result of Table 6 supports this point. The statistics in Model 1 of Table 6 shows that the net flow rate and expense rate affect the return of the next fund positively, while the turnover rate affects the return negatively.

In Table 7, we dividefundsintotwo groups based on whether the previous and nextfundswhich the winner fund managers manage belong to the samefundcompany or not. The coefficients of BRANK regarding the timing and stock picking ability in Table 7 are not significant. This resultindicatesthat the timing ability and stock picking ability of the nextfunds the winner fund managers manage are not persistent no matter the sucessivetwofundsthey manage are at the samefundcompany or not. It isnoteworththat the return of the nextfund the winner fund managers manage reverses when the twofundsbelong to the samefundcompany. The coefficient of BRANK is -1.293 and the t value is -1.8, which is significantly negative. Obviously, investors should not rely on winner fund managers too much. We further find that the male winner fund managers or the winner fund managers with Master’s or Doctoral degree who stay at the same fund company perform worse in the next funds they manage. However, the winner fund managers get benefit from such characteristic mentioned above when they manage the next funds in another fund company. This phenomenon indicates that if the fund companies want to recruit winner fund managers from other fund companies, they should choose male fund managers with higher education background.

Table-7. The Persistence of Fund Return, Timing Ability and Stock Picking Ability of Winner Fund Managers (change jobs to the other fund company or not)

Note: The statistics in the parentheses is t value.* significant at 0.10 level, **significant at 0.05 level, ***significant at 0.01 level.

4.2. Robustness Test

Table 8 aims to investigatewhether the probability of becomingperfromance (return , timing, stock picking) winners (1~0.8) of the nextfundswhich winner fund managers manage ishigher if the previousfundsthey manage are perfromance (return , timing, stock picking) winners. The coefficient of D_BWIN in Model 1of Table 8 issignificantly positive, whichindicatesthat the probability of becoming performance winners of the nextfunds the fund managers manage ishigherwhen the previousfundsthey manage are return winners (D_BWIN =1). However, the coefficients of D_BWIN in Models 2 and 3are insignificantly positive, whichindicatesthat the better timing and stock picking ability of previousfunds of fund managers does not guarentee the abilitypersistenc of nextfunds.

Table-8. The Probability of Becoming Performance (Return, Timing Ability, Stock Picking Ability) Winners of the Next Funds the Winner Fund Managers Manage

Note: The statistics in the parentheses is z value.* significant at 0.10 level, **significant at 0.05 level, ***significant at 0.01 level.

Table-9. The Probability of Becoming Performance (Return, Timing Ability, Stock Picking Ability) Winners of the Next Funds the Winners Fund Managers Manage (change jobs to the other fund company or not)

Note: The statistics in the parentheses is z value.* significant at 0.10 level, **significant at 0.05 level, ***significant at 0.01 level.

In Table 9, we further dividesfundsintotwo groups based on whether the previous and nextfundswhich the winner fund managers manage belong to the samefundcompany or not. The statisticsdemonstatesthat the probability of becoming timing or stock picking winners of the nextfunds the timing or stock picking winner managers manage is not significantlyhigher. Regarding the return winners, wefindthat the nextfunds have the higherprobability to become the return winners if the succesivetwofunds the return winner fund managers manage belong to the differentfundcompanies.

5. CONCLUSIONS

Past literature regarding the timing and stock picking ability (Grinblatt and Titman, 1993; Daniel et al., 1997; Bhojraj et al., 2012) or the persistence of these abilities (Fulkerson, 2013) are at the standpoint of mutual funds. Little literature investigates whether the timing and stock picking ability of the successive funds which the fund managers manage is persistent. That is, little literature investigates the management skill at the standpoint of “fund managers”. This study fills the gap of literature by adopting the two successive funds which are managed by the same winner fund managers as the sample to investigate whether the excellent timing and stock picking ability of winner “fund managers” is persistent or their good performance is just from good luck (Kosowski et al., 2006).

Regarding the whole fund managers, we find that the successive two funds they manage are performance persistent. Moreover, the stock picking ability of the two funds they manage is persistent no matter the two funds belonging to the same fund company or not. Regarding the winner fund manager, we find no persistence of return, timing ability and stock picking ability. No matter the winner fund managers change the jobs to the other fund companies or not, the next funds the winner fund managers manage are not timing and stock picking ability persistent. The result of logistic regression also demonstrates that the probability of becoming timing or stock picking winners of the next funds which the timing or stock picking fund managers manage is not significantly higher than other funds.This study focuses on the timing and stock picking ability of “fund managers”. The implications are as follows: 1. For fund companies, it is not necessary to recruit winner fund managers. Fund companies may pay more for the winner fund managers because of the good timing and stock picking ability of their previous funds. However, they cannot keep their excellent management ability, which will not necessarily bring positive influence on the fund companies. 2. For fund investors, when they are making investing choice, it is not necessary for them to follow the timing and stock picking winner fund managers. The performance of the next funds which the winner fund managers manage may reverse especially for the successive two funds belonging to the same fund company.

The evaluation of the timing and stock picking ability of this study is limited because only top 10 stock holdings are announced by the fund companies every month. And only stocks which market value in excess of 1% of the fund net assets are announced every quarter. This study therefore cannot collect the complete holding stocks of funds, which impedes our adopting of the stock holding approach. The following researchers may test whether the result of this study is robust if they have the holding data of funds every month.

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