If your mutual fund manager is also managing a hedge fund you may not be getting the best deal.
Sometimes called side-by-side management, the practice of having the same managers running mutual funds as well as hedge funds has attracted concern over potential conflicts of interest, as well as increased scrutiny and regulation from the Securities and Exchange Commission.
The worry: asset managers will be tempted by the potential for higher compensation from hedge funds to favor those clients, potentially allocating trades to the detriment of their mutual funds.
As part of an effort to address this and other concerns, the SEC in 2005 put in place mandatory new disclosures. Using data from these disclosures, a new study finds evidence that the mutual funds in side-by-side management arrangements lose out.
"We find that funds with side-by-side managers underperform ... peers without side-by-side managers, particularly when a fund's manager has a greater percentage of their assets under management outside the fund industry or has a relatively performance-insensitive mutual fund clientele," according to a study by Diane Del Guercio of the University of Oregon, Egemen Genc of Erasmus University Rotterdam and Hai Tran of Loyola Marymount University.
"Overall, our results cast doubt on the effectiveness of the monitoring and governance mechanisms that advisory firms put in place to mitigate the conflicts of interests due to side-by-side management."
Looking at data from the 30 largest U.S. fund families, which themselves represent about 75 percent of mutual fund assets, the study found that roughly 7 percent of managers are simultaneously steering hedge and mutual funds.
Mutual funds with at least one side-by-side manager underperform those without by 9.6 basis points per month, or 1.15 percentage points a year, using a standard measure of outperformance, or alpha, according to the study. What's more, the effect was only found when mutual fund managers run hedge money, not in similar arrangements when they run separate pooled accounts.
Funds that switch from not having side-by-side management to having it show even more striking underperformance: about 2.5 percentage points a year.
"We can rule out the alternative explanation that simply adding more assets under management leads to underperformance. Rather, the results specifically point to a performance decline only when the manager begins simultaneous management of a hedge fund," according to the study.