Mutual Fund Manager Research Paper

Mutual Fund Manager

Definition of the Fund Manager Position and Major Responsibilities

Securities and Exchange Commission defines a mutual fund as a company that pools money from many investors and invests the money in stocks, bonds, short-term money market instruments, other securities or assets, or some combination of these investments (U.S. Securities and Exchange Commission, 2008). Mutual funds are in turn operated by professional money managers, the fund managers, who invest the fund’s capital in accordance with the funds’ stated objectives, with the intent to produce capital gains and income for fund investors. This paper examines the role of the mutual fund manager.

Also known as an investment manager, the manager of a mutual fund is responsible for making all the investment decisions on behalf of the investors. The fund manager is tasked with implementing the fund’s investment strategy and managing it portfolio trading activities. For these reasons, investors look for specific attributes in fund managers, including long-term consistent fund performance by a fund manager whose tenure with the fund matches its performance time period. Because the whole point of investing in a fund is to leave the investment management function to the professionals, the quality of the fund manager is one of the key factors for investors to consider when analyzing the investment quality of any particular fund (Investopedia, 2011a).

The mutual fund manager or management team earns money from commissions paid by investors, as well as from a percentage of profits made by the fund. The mutual fund manager’s salary is dependent on the size of assets under his or her management and also the performance of investments that he or she initiates (Infotec-forums, 2011).

Given the amount of number crunching and analysis that a fund manager does, he or she should also be well versed in accounting, economics, and market research. A typical background for a fund manager would be to hold an undergraduate degree in economics with an MBA in finance, Certified Financial Analyst (CFA) credentials, and an apprenticeship under expert fund managers (Infotec-forums, 2011).

Along with other managers of the team that work in equivalent or subservient capacity, an investment manager must decide where to invest money. Some of the tasks which the mutual fund manager must carry out include market research, analysis of investment options, completing transactions, regularly monitoring the performance of existing investments, changing investing strategy according to market movement, and researching industrial sectors for investment opportunities (Infotec-forums, 2011).

Current Issues Impacting This Position

There has been some debate within the mutual fund community about how much impact the fund manager has on mutual fund performance. Studies have examined the relationship between mutual fund performance and fund managers. Baks (2003) determined that although manager performance for domestic diversified equity mutual funds was somewhat persistent over the course of their careers during the years studied, 1992 to 1999, that persistence did not necessarily imply that managers were important for determining a manager-fund combination’s performance. Baks concluded that managers were less important than the mutual fund itself for performance, that “as a rule of thumb, the results in this study indicate that performance is mainly driven by the fund.” He concludes that while mutual fund companies will undoubtedly continue to create star-mangers and advertise their past track-record, investors should focus on fund performance (Baks, 2003).

On the other hand, Russell (2011) argues that the evidence indicates that superior past professional performance among mutual fund managers tends not to persist and is not a predictor of future performance. He posits that if superior money managers actually exist, “then there should be dozens or hundreds of them who prove their superiority year after year.” As it happens, “the scientific finance literature indicates this is not the case” (Russell, 2011).

Other concerns that affect fund managers have to do with regulatory constraints. By law funds are required to be “fully invested,” which typically means that a mutual fund has only 2 — 3% of its funds in cash at any one time. Mutual funds are prohibited from going into cash by more than 10%. This requirement means that mutual funds are severely limited in protecting their shareholders during a time of crash or a bear market (Skousen, 2006).

Still another topic of interest to fund managers is mutual fund fees and expenses. As the SEC (2010) points out, fees and expenses are an important consideration in selecting a mutual fund because these charges lower the investor’s returns. The SEC suggests that investors comparison shop to review mutual funds fees and expenses, even providing a link to FINRA’s Mutual Fund Expense Analyzer on its website. The SEC justifies the importance it places on researching a mutual fund’s fees and expense by referring to independent studies showing that fees and expenses can be a reliable predictor of mutual fund performance (U.S. Securities and Exchange Commission, 2010a). The diligent fund manager will be appropriately concerned with activities and transactions the keep mutual fund fees and expenses reasonable.

There is also a relation between fund manager performance and information that investors glean from reading the fund’s prospectus. Many investors use the fund’s prospectus and accompanying Statement of Additional Information to inform their investment decision. Roth (2009) quotes Certified Financial Planner Neal Frankle’s advice to investors “If you invest in mutual funds and you want to understand what you are about to buy, you’ll have to thumb through the prospectus and Statement of Additional Information. These two documents tell you what the fund managers intend to do with your money — and how much they’re going to charge you for doing it” (Roth, 2009). Investors also find information on risk, returns, investment objectives and strategies in these documents, all considerations that the fund manager is concerned with.

Valuation Tools

The mutual fund manager is involved in determining the fund’s net asset value (NAV), which describes the total value of the fund’s assets, less all of its liabilities. Many mutual funds use the NAV to determine the price for transacting units of the fund; when investors buy and sell mutual funds, they typically do so at the NAV (Investopedia, 2011b).

Most mutual funds calculate the NAV daily since a mutual fund’s portfolio consists of many different stocks. Given that each of these stocks may change in price frequently throughout the day, it may be difficult to determine the mutual fund’s exact value. Consequently, mutual fund companies choose to value their portfolio once daily, and each day this process establishes the price at which investors must buy and sell the mutual fund. Mutual fund valuation techniques vary from fund to fund, with some choosing to use an average of the last three traded prices (Investopedia, 2011b). In addition to NAV calculations, the fund manager uses technical analysis tools in determining fund valuation.

One of the challenges the fund manager faces is valuing lesser known and illiquid securities. The non-availability of market quotes for illiquid securities necessitates qualitative valuation, which leaves room for manipulation and arbitrary assignment. Fund management has a duty to balance its obligations to disclose accurate NAV with selecting a valuation technique that is favorable to the mutual fund (Mahalakhshmi, 1999).

Use of Derivative Products

Derivatives are complex financial instruments whose value is derived from the value of the underlying assets. Mutual fund managers use derivatives such as futures and options for hedging their portfolio to manage risk, for speculation to make profits, and for arbitrage to earn risk-free profits. Some analysts advocate that hedging should not be considered as a vehicle for making money, believing that the best it can achieve is minimizing risk. Similarly, speculating in derivatives is a double-edged sword for the fund manager, given the possibility of making profits or incurring losses depending on how the fund manager’s call works out. Using arbitrage as a strategy may shield the fund against market volatility, but it typically produces lower returns than those from equity funds (Rediff, 2006).

The SEC expressed concern over the use of derivatives in it press release of March, 2010, announcing that it was conducting a review to evaluate the use of derivatives by mutual funds along with exchange-traded funds (ETFs) and other investment companies. The SEC was concerned if additional protections are necessary for those funds under the Investment Company Act of 1940. SEC Chairman Mary Schapiro announced that “It’s appropriate to engage in a more thorough review of the use of derivatives by ETDs and mutual funds, given the questions surrounding the risks associated with the derivative instruments underlying many funds” (U.S. Securities and Exchange Commission, 2010b).

The mutual fund manager will be impacted by the SEC ruling on derivatives, following its exploration of the following issues to determine whether:

Fund boards of directors are providing appropriate oversight of the use of derivatives by funds

Existing rules sufficiently address matters such as the proper procedure for a fund’s pricing and liquidity determinations regarding its derivatives holdings

Existing prospectus disclosures adequately address the particular risks created by derivatives

Funds’ derivative activities should be subject to special…