How lower-class fund managers outperform the rich kids
A new study shows inherited privilege is no guarantee of talent
The old adage about the rich getting richer and the poor getting poorer may have lost its punch when it comes to the professional fortunes of mutual fund managers.
A new study, which shows fund managers who are raised poor actually achieve better returns than their well-connected and purportedly better educated counterparts, offers significant food for thought – not only for investors about who's managing their money, but also for financial services firms and regulators worldwide.
The famous old boys' club may have to close down as the pioneering research prompts a rethink of who gets hired and who gets promoted to manage the wealth of others, according to co-authors Oleg Chuprinin, a senior lecturer in banking and finance at UNSW Business School, and Denis Sosyura, assistant professor of finance at the University of Michigan.
Indeed, many positions attained through 'who you know' in corporate management and professional services may need to replace their prestige barriers to entry with a new set of criteria in the wake of the findings, suggest the researchers.
More urgently, though, "maybe you should know more about the background of your fund manager", says Chuprinin, who has long been curious about the impact of fund managers' personal histories on their professional lives.
'It’s the first time a link has been established between the family descent of investment professionals and their ability to create value’OLEG CHUPRININ
Funds management is a comparatively young industry that began growing significantly in the 1960s and has seen exponential growth in recent decades. In 2013, ICI Global reported the assets in mutual funds worldwide at US$29 trillion.
Until recently, it has not been possible to explore the financial circumstances of fund managers' early lives. With the release of the 1940 US census data in 2012 – US law requires personal data to be kept under wraps for 72 years – Chuprinin and Sosyura seized the opportunity to kick off their exhaustive research project.
Working with the names of more than 300 US fund managers born around 1940, the researchers spent a year and a half hand-collecting and cleaning the data, and searching through records of births, deaths and marriages to verify familial connections and other details.
To determine if the fund managers had grown up rich or poor the pair used the census data on income of fund managers' parents, the rent they paid (average monthly rent for the poorest 10% of families in the study was US$14, while the richest 10% paid US$70), or the value of their homes (an average US$2500 for the poorest 10% and US$20,000 for the richest 10%).
These numbers should be multiplied by roughly 60 to allow a meaningful comparison with today's values.
Controlling for factors such as the manager's own skill set and the family's expertise – did a parent work in the finance industry? – Chuprinin and Sosyura then correlated the financial circumstances of fund managers' formative years and their subsequent career progression with the economic outcomes of the funds they supervised.
They found that fund managers who were born rich did not produce richer results – in fact, quite the opposite. Those born into a life of privilege, whose families could afford to send them to top schools and who often were promoted into leadership roles with the help of their inherited status, wealth or access to professional networks, were outstripped by their less privileged peers, when it came to fund performance.
The gap in risk-adjusted performance between the richest and the poorest 20% was about 1.5% per year.
The surprising finding delivers a slap in the face for firms with elitist hiring practices – that show a preference for top-school graduates, for example – and reveals a potential hole in investors' hip pockets.
"It's the first time a link has been established between the family descent of investment professionals and their ability to create value," notes Chuprinin.
‘If it’s a signal of quality, in future there may be legal implications for disclosing the backgrounds of fund managers’OLEG CHUPRININ
In their paper, Family Descent as a Signal of Managerial Quality: Evidence from Mutual Funds, Chuprinin and Sosyura report the results of a "promotions test" that looked at increases in funds under a manager's supervision beyond the returns they earned. It showed that managers born rich are more likely to get ahead in their careers – that is, they are given responsibility for more funds.
The researchers retrospectively 'joined the dots' between promotions (which were measurable) and the earlier hiring stage (which they could not observe) and determined, similarly, it would have been easier for rich candidates to get an initial foot in the door, so managers born poor must have faced higher barriers to entry into the fund management industry.
"Candidates from wealthy families who turn up with spectacular references and prestigious degrees face less stringent screening standards and, for a given level of skill, are more likely to be appointed managers, whereas only the most skilled ones from poor families will be hired in the first place," explains Chuprinin.
"While we can't single out individuals who should have been promoted and weren't, we saw a pattern over 30 years."
Perhaps those born poor may have been motivated to work harder and been hungrier for those better returns?
"It's a plausible hypothesis, but we can't draw that conclusion because their effort is not directly observable," Chuprinin says.
In line with the notion that those raised poorer may have felt the need to strive harder is the study's discovery that fund managers who were poor kids tended to be active investors who traded more frequently.
Signal of quality
The study raises many questions, particularly in an era of burgeoning superannuation wealth which is substantially allocated to mutual or managed funds. The importance of selecting the most capable managers is paramount.
Currently, information about the family background of investment managers is not widely available. A short profile on the firm's website or in an annual report may be the best the curious investor can find.
"If it's a signal of quality, in future there may be legal implications for disclosing the backgrounds of fund managers," predicts Chuprinin.
However, he's quick to emphasise that the results of a survey of the past 60 years may not hold for the next 60. "Times may have changed," he says. "It may be that the finance industry is more egalitarian than it used to be. It's also bigger."
The average fund manager in the sample was born in 1938, and while the nascent finance industry was difficult to break into without the backing from family or friends, "we can't be sure that the selection process is as stringent today as it was in the 1960s and '70s".
Nonetheless, the researchers contend their study using US data is relevant to many highly competitive fields globally.
"Social status at birth may serve as an important signal of quality in other industries with high barriers to entry. It's common knowledge that in prestigious jobs it's important to have the right references and know the right people.
"If someone without those credentials can break through the barriers to get in, then that is a very special person who deserves attention," Chuprinin concludes.
"We need to understand more about how individuals from poorer backgrounds overcome such barriers without social support."