AMERICAS INVESTMENT
To the max
Optimizing returns on mutual funds By Karen Schnatterly, Emma S. Hibbs Distinguished Professor of Management at the Robert J. Trulaske, Sr. College of Business at the University of Missouri There was good news for the mutual fund industry earlier this year when it was reported that more funds in the US are beating the market than they were a year ago – and that 2015 was turning out to be the best year for returns since 2012. Despite this, a research project I carried out recently - Independent boards and the institutional investors that prefer them: Drivers of institutional investor heterogeneity in governance preferences - suggests that fund managers could do more to make sure their customers have the best chance of maximized returns. How mutual funds invest is a hot topic globally and regulators are becoming increasingly concerned with practices in the industry. For example, so-called ‘Shadow Banking’ has been scrutinised on both sides of the Atlantic and the Securities and Exchange Board of India (SEBI) recently asked asset managers to conduct monthly stress tests on their mutual fund portfolios in order to improve risk management across the sector. There has also been attention paid to the issue of corporate boards with the common consensus that independent boards are ‘better’ than boards that have strong links to a firm’s top executives. 50
Summer 2015
But what impact does the make-up of a corporate board have on mutual funds’ investment strategies? Stockholders, especially those in the US, believe that the board’s primary function is to monitor the CEO and to make sure that the shareholders’ best interests are represented. Therefore, the logic goes that the best way to make sure this is the case is to have a board with as few ties to the CEO as possible to balance the power of the CEO with that of the board. Surveys of portfolio managers show that institutional investors say they prefer to invest in firms that have more independent boards. But is this because it’s the best option for the people they represent – or is it something else? One explanation could be that investors prefer independent boards because they provide better monitoring of top management, which reduces agency costs - therefore improving shareholder returns. Another theory is that institutional investors prefer independent boards because it signals appropriate, or generally accepted, behaviour regardless of it being tightly linked to the operation of the firm. If the preference amongst fund managers for independent boards is driven by the desire for lower agency costs, then it would make sense that differences in institutional investors’ trading strategies would lead to differences in preferences for board independence—an investor with a buy-and-hold strategy is likely to view agency costs more seriously than an investor with a much shorter time horizon.