When a "Star" Portfolio Manager Retires

In a recent article about the turmoil that can erupt when a mutual fund loses its lead manager, the Wall Street Journal recommends that investors start asking questions about a portfolio manager’s retirement plans as soon as the writing is on the wall. “While many fund managers work successfully into their 70s and 80s, it’s fair to start asking questions about their role once they reach their 60s,” the author suggests.

And that’s exactly the kind of questions investors have been asking about Bill Miller, the 60-year-old manager of the flagship Legg Mason Capital Management (LMCM) Value Trust and chief investment officer of LMCM in Baltimore. Responding to clients who were clamoring for details about Miller’s long-term career plans, the company posted a message on its Web site in mid May, announcing that Sam Peters would join Miller as co-manager later this year, identifying Peters as Miller’s “eventual successor.”

In a move that is unusually proactive for the mutual fund industry, Legg Mason made a formal, explicit announcement about a succession plan long before the manager’s retirement date was announced, and even before the heir to the throne joined the management team. Drew Bowden, who heads LMCM’s sales and marketing efforts, told FRC the announcement did not coincide with any particular market event; however, the firm wanted to give clients and gatekeepers plenty of time to get acquainted with Sam Peters before Miller passes the baton. “The last thing in the world you want to do is to catch your clients by surprise with an announcement like
that,” Bowden told FRC.

Consistency is Key

Obviously, the key message Legg Mason wants to communicate to financial advisors and investors is that there is a formal succession plan in place, and that the fund’s investment approach will remain unchanged. “The planned addition of Sam to Value Trust is another important step in the continuing evolution and improvement of our investment team,” states the firm’s Web page. “We are confident that it will better position us to continue to serve clients through the consistent application of the investment philosophy and process [italics added] that has been Bill's life work for the last 28 years.”

A number of other prominent funds could also be poised to pass the torch over the next several years, as managers are lured away by hedge funds (which aren’t subject to the compensation restrictions imposed on banking institutions), newly merged asset management firms such as Columbia Management rationalize their fund lineups and veteran portfolio managers ease into retirement. Market turmoil in 2008-09 also could encourage lingering turnover: Morningstar reports that fund manager turnover jumped from 24% after the dot-com bubble burst in 2003 to 39% just three year later. “Historically, a fund manager exodus has often come a few years after a tough spell in the market,” the Wall Street Journal reported.

The Passive Approach

The passive approach appears to be one of the most common approaches to portfolio manager retirement. In other words, old portfolio managers don’t retire, they just fade away. Consider the case of 106-year-old Roy Neuberger, cofounder of Neuberger Berman and the Neuberger Berman Guardian Fund in 1950, who still has an office at the firm’s headquarters in Manhattan. Or 92-two-year-old Ernie Kiehne, co-founder of the Legg Mason Capital Management Value Trust Fund and a “Portfolio Manager Emeritus” at Legg Mason Capital Management. It appears that 69-year-old Star Manager Ken Heebner of CGM Funds might also work as long as possible, stating repeatedly that he has no plans to retire, ever. But these assurances have done little to assuage the concerns of investors, including the author of a recent Kiplinger’s article about manager turnover: “The first question to ask is: How important was the manager in the first place? If it's a oneman show, like Ken Heebner's CGM Focus Fund, then the loss is critical.”

Other firms prepare for a retirement by quietly adding staff, gradually moving away from the appearance of a one-man show. At Royce & Associates, for example, 70-year-old founder Chuck Royce has “no plans to retire or reduce his role,” said Kristen Swenson, director of communications and marketing. Still, the company has surrounded him with a strong team. “The senior management team consisting of Chuck Royce, [co-CIO] Whitney George, John Diederich, and Jack Fockler has worked together for more than 15 years,”said Swenson. “In terms of our portfolios, the firm works on a back-up system whereby portfolios include co-managers, lead managers, and/or assistant managers.” Swenson says a deep bench enables the firm to deal effectively with any short- or long-term absences on the team.

Statistically, a Non-Event

Although portfolio manager retirement is an emotional event for some investors, it may be relatively insignificant when measured more dispassionately — provided investors have sufficient warning. In his book Mutual Funds: Risk and Performance Analysis for Decision Making, University of North Carolina professor John A. Haslem contends the typical mutual fund is unlikely to experience any significant disruption of investment style or performance when there is a formal succession plan. “Planned succession includes installation of protégés, installation of former portfolio manager team members, and family members with successful portfolio manager experience and the desire to succeed,” he writes.

While new managers are usually eager to make their mark on a fund, Haslem says that the momentum and trajectory of the fund’s performance before the transition may be more influential than the manager’s desire to make changes. Citing research from Morningstar analyst Scott Cooley, Haslem points out that mutual funds with strong performance numbers at the time of the transition usually continue to perform well afterwards. Funds with weak performance continue to perform poorly after the shift.

American Funds’ Approach

One firm that virtually eliminated the uncertainty surrounding portfolio manager transitions is American Funds, which has used its co-called Multiple Portfolio Counselor System for the past 50 years. Under this model, each fund’s assets are parceled into smaller sleeves that are managed individually by different PMs and analysts, all supervised by a lead manager and investment committee. “Our unique approach to managing funds blends teamwork with individual accountability,” the firm says.

“Counselors can be added to a fund as assets grow. If one manager retires or leaves the fund, only a portion of the fund’s assets changes hands.” There are more than 40 decision-makers associated with Growth Fund of America,according to a firm spokesman. On the other hand, the team approach does have some disadvantages, not the least of which is the absence of a “thought leader” or patriarch to establish and nurture one-on-one relationships with gatekeepers. While American Funds admits that the Star System helps investors associate a particular personality with a particular fund, American Funds’ portfolio managers rarely meet with financial advisors. And when they do, it is typically part of a panel discussion. “We believe the consistency of management and the lower volatility that accompanies the Multiple Portfolio Counselor System outweigh the advantages of having a single,Star Manager,” spokesman Chuck Freadhoff told FRC.

In fact, the entire industry may be leaning more toward this multi-manager approach in the future. Morningstar Direct reports that there are currently 2,096 mutual funds with individual portfolio managers and 4,659 with multiple managers.

Conclusion: Communicate

Naturally, the transition from a Star Manager to a subordinate will be much smoother for funds using computerized, quantitative analysis techniques than will be for funds with managers who have a reputation as strong individual stockpickers or managers running very concentrated or sector-specific funds. But either way, it is clear that plenty of preparation and clear communication with investors and financial advisors will go a long way toward easing the anxiety that accompanies a changing of the guard.

It would be in the best interest for firms like CGM, with well-known and strong-performing managers, to develop a formal succession plan long before the manager turns 60. In fact, a formal succession plan should be firmly in place regardless of the manager’s age. In an industry where the only “constant” is change, it is wise to acknowledge the issue of portfolio manager turnover, develop a contingency plan, and communicate it early and often. — Michael Hayes
(michael.hayes@frcnet.com)