School Ties of Mutual Fund Managers and Corporate Board Members Affect Fund Returns Finds Study
New Haven, Conn., April 9, 2007 — Private information passed through the social networks of mutual fund portfolio managers and senior company officers who attended the same university affects fund returns, finds a new study.
Portfolio managers overweight stock holdings of firms that are run by individuals in their education network and earn higher returns on these “connected” holdings than non-connected holdings according to “The Small World of Investing: Board Connections and Mutual Fund Returns” by Lauren Cohen of the Yale School of Management, Andrea Frazzini of the University of Chicago, and Christopher Malloy of the London Business School.
A portfolio of connected stocks held by fund managers outperforms non-connected stocks by up to 8.4% per year.
The authors attribute this connection premium to fund managers gaining advantageous information through their education networks. They determined this by analyzing biographical information of fund managers and senior company officers, and the fund managers’ trading decisions in firms that have senior officers in their education network, and outside of it. The overweighting and returns were not driven by industry, firm, fund, or school characteristics. Instead, the authors found that fund returns were concentrated around corporate news announcements. Portfolio managers earned significantly higher returns on connected holdings in the months when news was released from firms in their network, while there was no difference in returns of non-connected stocks in months of news or no-news.
The authors also found that portfolio managers do not overweight all stocks that are connected to their education network; they predict the right connected stocks to overweight — those that perform well — and choose not to hold connected stocks that under-perform.
The findings also show that both the overweighting and return predictability increase with the strength of the social connection. The highest level of connection — a portfolio manager and senior company officer who attended the same school, at the same time, and received the same degree — results in a 47% overweighting relative to non-connected stocks, and excess portfolio returns of 16.05%, annually on average, compared to 7.71% for all holdings, and 7.69% for non-connected holdings.
“We know that information moves security prices, but we didn’t predict that there would be such a pervasive pattern between education networks and fund returns,” said Cohen, an assistant professor of finance at the Yale School of Management. “The social networks formed through education background, which are often established decades in advance, allow portfolio managers to gather information on firms. This is not an isolated situation or constrained to a few portfolio managers or firms; it’s a systematic effect across portfolio managers and firms.”
The study data also allowed the authors to quantify how “connected” universities are to both publicly traded firms and to mutual funds. Of the 354 schools in their sample, the five most connected are reported in the paper: Harvard, Stanford, Wharton, Columbia, and NYU. At the top, Harvard is connected to 59% of the market value for all publicly traded firms and to 54% of all of the assets under management by active equity mutual funds.