For investors, one of the key selling points of mutual funds is that someone manages the portfolio of stocks, bonds and other assets for you. Whether it be actively managed or a passive index, there is a human being driving the fund. And while that fact may not seem that important, it has a huge bearing on just how the fund will perform over time. A quality fund manager can make or break your investment. So, what exactly does a fund manager do? Read on to find out.
Key Duties of Fund Managers
For actively managed mutual funds, the fund manager is basically in charge of what stocks, bonds or other assets the fund will buy with investors’ money. Essentially, the fund manager will function as a stock-picker. Focusing on price-to-earnings ratios, price momentum, sales, earnings, dividends and other various metrics, the fund manager will build a portfolio of assets to accomplish the aims of the mutual fund. Those aims (growth, value, income etc.) are spelled out within the mutual fund’s prospectus.
While fund managers do have some leeway, these aims help the managers hone in on certain sectors or styles pertinent to the individual mutual fund. In addition, the manager will evaluate risks—both single stock and macro-economic—versus potential returns.
On a daily basis, the fund manager will often be in charge of actually placing orders and buying/selling individual stocks/bonds from the portfolio. Some smaller funds also have the lead manager conduct marketing and back-office duties, as well as establishing ethical standards for the business.
For larger mutual funds, the lead fund manager is often supported by a staff of analysts, traders and other people who monitor the markets, make trades and perform other duties at the fund. This support staff is critical in making sure the fund operates in an efficient and profitable manner. However, it is the lead mutual fund manager’s job to guide the overall direction of the portfolio. Ultimately, he or she is calling the shots on just what it will own and when.
Sometimes, mutual funds are managed by a committee process – such as with the Dodge & Cox family funds. Here, lead fund managers will bounce ideas off of each other and stocks are selected via a vote. Another common approach is a multi-manager fund. Here, each management team is given a percentage of the fund’s assets to guide and are only responsible for those dollars. A single lead manager will decide on who will be responsible and how much of the fund’s assets are given to manage. Several of Vanguard’s popular mutual funds use this methodology.
Evaluating a Fund Manager
Figuring out just how effective a fund manager is comes down to performance relative to their target benchmark. Each fund looks to target a certain index as the guide for investment. For example, a large-cap blended stock fund may look towards the venerable S&P 500, while a broad-based bond fund will use the Barclays U.S. Aggregate Bond Index. The general idea for a fund manager is to “beat” the performance of that index in a given year. The extra return is how actively managed mutual funds justify their expenses.
How they do this is via what’s called “style-drift.” Basically, it’s how much play the mutual fund manager has with regards to changing the weighting in its target benchmark. He or she may over or underweight certain sectors (like adding more tech or reducing utilities, for example) versus their benchmark index to gain additional returns. The fund’s prospectus will outline exactly the maximum and minimum amount a fund manager can stray.
Ratings services Morningstar and Lipper help individual investors by taking all the funds in certain categories (large-cap growth, developed market international, etc) and comparing them to each other. Morningstar will apply a star-rating system to the funds – with the top funds in a group earning four or five stars. These are generally funds that “earn” their expenses above their target benchmarks. Lipper uses a similar system of above average or below average to gauge a fund’s performance.
Be sure to also see What is a Mutual Fund Management Fee?
Index Fund Managers Are Different
For index funds, the managers have a slightly different purpose. In a full-replication index, a fund manager’s job is buy all the stocks within that respective index. A full-replication S&P 500 index fund will own all 500 stocks in the index. The fund manager’s job is to manage inflows and outflows of the fund and buy/sell stocks accordingly to continue matching the index.
However, not all index funds use a full-replication strategy. Some will only buy most—but not necessarily all—of the stocks within the benchmark index. The idea is that the fund will attempt to closely match the overall investment attributes of the index. The fund manager’s job here is to buy/sell stocks within the index to closely match the sector weightings and provide a large spread of firms to cover the underlying index. This sort of indexing strategy is most likely found in international and emerging market funds, where buying all the stocks within an index could prove difficult.
The Bottom Line
For investors looking at adding mutual funds to their portfolios, the fund manager is one of the biggest pieces when deciding which fund to select. It is he or she that will ultimately guide the investment of the underlying portfolio. By functioning as stock- or bond-picker, the fund manager is responsible for making sure the portfolio is earning a market-beating return.