Part of our research focuses on how experience shapes job performance in the money management industry. In the featured article, we consider experience outstide the investment industry – but does experience within the financial sector also matter?
An analyst is not an analyst
In their 2018 Financial Management paper “Mutual Fund Managers’ Prior Work Experience and Their Investment Skill”, Chen, Gao, Zhang, and Zhu examine the investment behavior of fund managers who worked either as a macroanalyst or industry analyst:
- Macroanalysts forecast and analyze macroeconomic trends and government policies that may affect markets. They have a better understanding of overall risk factors and are able to forecast macroeconomic trends.
- Industry analysts, on the other hand, cover companies that belong to a certain sector or industry and gather a huge body of information about particular companies.
Chen and coauthors hypothesize that these different types of experience lead to different skills of a fund manager: former macroanalysts are better at market timing, former industry analysts show better stock picking skills. They analyze their hypothesiss using a sample of Chinese mutual fund managers from 2003 to 2016.
Measuring timing and picking skill
To measure stock picking skill, Chen and coauthors compute the risk-adjusted excess return (Carhart alpha, the intercept of a regression of fund returns on four risk factors and the squared market excess return). Market timing skill is given by the coefficient of the squared market excess return. The intuition for this is as follows: If a manager can time markets, he can generate positive returns both when markets rise (positive returns) and when markets fall (negative returns).
Who is better at which task?
To estimate the two measures, the authors form equally weighted portfolios for the whole manager universe (1), macroanalysts (2), industry analysts (3). Table 1 displays Carhart alphas and timing coefficients for the three samples, as well as for the difference between two groups (industry analysts minus macroanalysts).
|Table 1: Carhart alpha and market timing for fund managers with different analyst experience|
|All||Macroanalysts||Industry analysts||Industry analysts – macroanalysts|
|Market timing coefficient||9.90*||17.98***||6.73||-11.25*|
*** and * indicate significance on a 1% and 10% level, respectively. Source: Table 2, Chen et al. (2018).
Table 1 shows that on average, macroanalysts achieve a monthly alpha of about 0.25% and industry analysts an alpha of 0.65%. The difference between the two groups is statistically significant at the 10% level, suggesting that industry analysts are better at stock picking. Reversely, the market timing coefficient for macroanalysts is signifcnalty higher coefficient than for industry analysts. Hence, macroanalysts are better at timing the market compared to industry analysts.
Alternative explanation: Fund and manager characteristics
It is clear that many factors other than prior work experience can influence performance. Also, prior working experience is related to fund or manager characteristics which are the underlying drivers of performance. Hence, Chen and coauthors re-run the model with fund age, size, turnover and expense ratios and fund manager gender as additional variables. But even including these conrols, the main results still hold.
Take-away: Experience shapes skill!
In summary, Chen and coauthors find that the professional background matters for fund managers skills: different experiences lead to different skills. Investors and fund management companies should take this into consideration when making their decisions. So: Always have a look at the CV!