In a previous post, we gave a preview of the CFR Colloquium. One paper presented there analyzes the impact of a fund managers’ military background on fund flows. Alexander Cochardt, Stephan Heller, and Vitaly Orlov, University of St. Gallen published their working paper in February 2019.

Does trust matter?

The authors argue that trust plays an important role when it comes to investment decisions:

  1. Most mutual funds and investment advisers build their advertisement on trust rather than past performance (Mullainathan, Schwartzstein and Shleifer, 2008).
  2. Gennaioli, Shleifer, and Vishny (2015) show that trust in a manager reduces the risk an investor perceives, and that helps justifying management fees.

In the military we trust

Cochardt, Heller and Orlov interpret trust as confidence in the mutual fund manager. This confidence is based on the respective background, namely prior involvement in the military. The main hypothesis of this paper is that managers with military background receive higher flows compared to managers without military background.

Managers with military background

The authors use monthly data on actively managed domestic U.S. equity mutual funds from 1992 to 2017. The data sample consist of 1,857 managers, managing 2,448 funds. Among these managers, 112 have some military background. The main explanatory variable is a dummy variable that equals one if the manager has a military background, and zero otherwise.

Trust matters

The first results of Cochardt, Heller and Orlov indeed confirm their hypothesis. Military-experienced managers receive higher fund flows compared to nonmilitary-experienced managers.

Table 1: Impact of military background of fund managers on mutual fund flows
  Dep. variable: Fund flow
Military 0.012*** 0.003***
Fund return 0.071***  
Performance rank   0.011***
Lagged fund flow   0.381***

*** indicates significance on a 1% level. Source: Table 2 of Cochardt, Heller and Orlov (2019).

Table 1 shows the regression results. The respective Military coefficient is positive and highly significant. Funds with military-experienced managers grow by about 4.0 to 14.4 annualized percentage points more compared managers without such experience.

Does it pay to be a hero?

Naturally, the degree of experience varies across managers: Some only have military training, others are medal-decorated war veterans. If trust is the main effect, then more experienced military managers should have even higher inflows. Hence, the authors distinguish between managers that served a tour of duty in a conflict zone (Conflict/Medal) and those who only underwent  military training (Military training). Table 2 shows the associated results.

Table 2 : Amount of involvement and mutual fund flows
  Dep. variable: Fund flow
Military 0.010*** 0.010***
Military * Conflict/Medal 0.014** 0.014**
Military*Military training -0.005  

*** and ** indicate significance on a 1% and 5% level. Source: Table 4 of Cochardt, Heller and Orlov (2019).

The coefficient of Conflict/Medal is positively and significantly related to fund flows: War veterans receive 16.8% more flows compared to those who only disclose that they served in the military. The coefficient of Military training however, is negative and statistically insignificant.

Are heroes better fund managers?

One possible explanation for this investor behavior is that fund managers with military background simply perform better. Hence,  performance-chasing investors prefer their funds. The authors exclude this possibility, however: Fund managers with military backgrounds generate no outperformance, nor more stable performance. This suggest that rational performance-chasing behavior by investors is unlikely to explain the results.

In a nutshell: Being ex-military pays off for managers, but not for their investors

From the fund family’s perspective, it pays to have managers with a military background: they generate significantly higher fund flows. From the investors’ point of view, however, ex-military managers generate no superior performance.

Author: Monika Gehde-Trapp