Should You Invest with the Fund Manager of the Year?

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Morningstar’s Fund Manager of the Year (FMOY) is one of the most coveted awards in the mutual fund industry. Indeed, fund companies devote enormous resources to promoting award recipients. But should advisors invest their clients’ funds with those winners?]

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A new study, Superstar Fund Managers: Talent Revelation or Just Glamor?, provides the answer. It was written by Australian- and New Zealand-based professors, Jerry T. Parwada of the University of New South Wales and Eric Tan of the University of Otago.

It has been well-known that awards, such as upgrades to a fund’s Morningstar “star” ratings, drive asset flows to funds. In fact, inclusion in the Wall Street Journal’s “category kings” has been shown to boost assets by as much as 31%. But the perennial question is whether such awards are predictive of future risk-adjusted outperformance.

Morningstar selects its FMOY winners based on an expectation of future alpha. Here is how Morningstar presented its 2016 winners:

o be nominated for Fund Manager of the Year, the manager’s mutual fund must be among the 1,200 that receive Morningstar Analyst Ratings and earn a rating of Gold, Silver, or Bronze. The medal rating indicates that our analysts believe a fund will outperform its category peers and/or benchmark on a risk-adjusted basis over the long haul. Looking at their individual coverage lists, analysts nominate Morningstar Medalist funds that have strong recent and long-term risk-adjusted returns, excellent stewardship practices, and broad shareholder bases. Our asset-class teams whittle down the list to a group of finalists. Then the entire analyst team meets to debate the merits of the finalists in each category, and, following those discussions, analysts vote to determine the winners.

Morningstar has issued its FMOY awards since 1987, but the study focused on the results from 1995 to 2012 and used only the domestic-stock category. The authors analyzed each year’s winner relative to the other medal finalists announced by Morningstar. This allowed them to isolate the effect of winning the award.

I’ll review what the study found with regard to whether FMOY awards drive asset flows, predict future outperformance and lead to greater risk taking by fund managers.

How awards benefit fund companies

FMOY winners garnered 21.2% more assets over the 12-month period following the award announcements. The average fund had $193 million in assets at the time of the award, so this translates to $41 million in additional assets over the next month, according to the authors.

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