When Your Fund Changes Managers

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Fidelity Investments President Rodger A. Lawson says he’ll step down in March. It’s kind of insider baseball news that doesn’t matter an awful lot to most investors. But it points to another question that does:

A fund manager’s advancement, demotion, lateral move, retirement or death can have a big effect on a fund’s performance, even if the basic strategy stays the same under someone new.

Unfortunately, there’s no way to know for sure if the successor will be an improvement or not. There are plenty of examples of both. The investor can only look at the specific case and weigh the possible outcomes.

If the fund has done well, the law of averages says investors should be concerned about whether a successor will be as good as the superstar who has left. If the fund has done poorly, a manager change might be cause for optimism. But why would you stick with a fund that hasn’t done well? You’d need a compelling reason, such as the hiring of a stellar new manager.

Evaluating managers is difficult. You have no choice but to look at past performance, but even if the manager has had a string of benchmark-beating years, it’s next to impossible for anyone, especially laymen, to know for sure if the record was the result of skill rather than luck.

In fact, you may need two or three decades of results to have a statistically significant record, which would have to cover various types of bull and bear markets. Many managers haven’t been around that long, and those who have may not have that many working years left.

Many investors find their tax bills going up after a new manager changes the fund holdings. Profits earned on assets sold during the year must be paid to shareholders in year-end distributions, which are taxable unless the fund is in a 401(k), IRA or similar tax-favored account.

The new manager, for example, may simply feel that some of the fund’s holdings should be sold to make room for others, either because she thinks the old ones were bad choices or because she has a slightly different strategy. The fund also may be forced to sell assets if the change in managers causes a flood of shareholder redemptions.

Of course, taxes could also be triggered if you decide you no longer want to own the fund. You’d face short- or long-term capital gains tax if you sell shares for more than you had originally paid.

Morningstar Inc. (Stock Quote: MORN), the market-data firm, suggest that investors explore four questions after a manager change is announced:

  • How important was the old manager to the fund? Funds run by teams, or funds that follow a rigid strategy, are less dependent on the top manager than others.
  • Will there be a smooth transition? An abrupt firing or death with no successor named right away is more likely to be damaging than a long-expected retirement.
  • Will the fund’s strategy change? Even if a strategy change will produce better returns, the fund many no longer suit your needs.
  • What’s the new manager’s track record? Obviously, a better track record is more desirable than a middling one. But even a good track record should be probed for signs it was caused by good stock picking rather than market conditions.

Bottom line: A fund undergoing a manager change should be seen as a new fund, subject to all the scrutiny you’d give any fund you don’t know much about. Of course, index-style investments, either mutual funds or exchange-traded funds, are less likely to suffer from manager changes than actively managed funds, since indexers’ autopilot investing strategy gives the manager less influence.

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