How We Think About Manager Changes
Why manager changes are different at Vanguard and T. Rowe Price.
|The article was published in the March 2021 issue of Morningstar FundInvestor. Download a complimentary copy of FundInvestor by visiting the website.|
In January, T. Rowe Price announced that manager Larry Puglia will retire from T. Rowe Price Blue Chip Growth (TRBCX) after a great run dating to 1993. After the announcement, we maintained our Above Average People and Process ratings and a Morningstar Analyst Rating of Silver.
No, we weren’t downplaying Puglia’s role or skill. Rather, we saw this coming and were comfortable with the situation. T. Rowe Price generally maps out manager transitions over a two-year period, so the new manager has time to get up to speed and investors have time to research the change.
In January 2020, T. Rowe Price named Paul Greene as associate manager. It didn’t say when Puglia would retire, but he was 60 years old at the time, and the firm’s managers typically retire between the ages of 60 and 64. We knew Greene from a successful run at T. Rowe Price Communications & Technology (PRMTX), which he had managed since 2013. It was good experience, though T. Rowe Price Blue Chip Growth is a huge step up in asset size and has a wider investment universe.
We evaluated the change in 2020 and lowered the People rating to Above Average and Analyst Rating to Silver in anticipation of the transition. Thus, when the announcement came in January 2021, we didn’t see a need to revise our ratings.
Let’s look at how we evaluate manager changes so you can use our Analyst Ratings wisely.
We watch SEC filings and frequently check with fund company contacts for manager changes. When they happen, we generally do a complete review and rerate the fund. Sometimes we take an interim step in which we place the rating under review while we gather information on the changes.
Sometimes we decide a manager change is sufficiently minor to merit just a Fund Analyst Note—to share the information with you—rather than a full review. A lead manager that isn’t changing or a team adding a fourth manager with no one leaving are examples of when we might not do a full review. In examples like T. Rowe Price Blue Chip Growth, when we already knew a change was coming and factored that into our ratings, we also might just publish a note. Here are some key questions our analysts will ask:
1. Why was there a change?
If the firm fired the manager or nudged him or her out, then there’s a decent chance the new manager will alter if not overhaul the strategy--since we know the fund company wasn’t happy with how things were going. If the manager left to run money elsewhere, it tells us the company may have problems retaining people, but it doesn’t mean it will change the strategy.
2. Is the new manager steeped in the strategy?
When the new manager comes from the team running the strategy, that suggests the fund’s strategy will stay largely intact.
3. What’s the new manager’s record managing money?
There’s a big difference between someone who has had buy/sell authority on strategies versus someone who was an analyst. If we’ve spoken to the new manager prior to the change, it bolsters the case that he did have some authority. And the longer the record, the more helpful it is in assessing the manager’s skill.
4. How relevant is the record?
A manager who ran a transportation fund before taking over an equity-income fund doesn’t get much credit. On the other hand, if a manager ran something similar or the same strategy only with a different market-cap universe, we may put more faith in her record. In addition, it matters how much money was managed and in what kind of vehicle. For example, a hedge fund record may be of limited use in extrapolating how a manager will do with a mutual fund as the rules are very different. The challenge of managing daily cash flows also is unique to mutual funds.
5. Will the approach change?
Of course, we don’t just look for signals of a change--we ask the fund company and the new manager directly. Sometimes they have quite a bit of detail about changes they plan to make. Sometimes they say they aren’t making changes, and a portion of those times that turns out to be the case. That’s why we keep a particularly close eye on a fund in the two years following a change.
After completing their research, the analysts decide how to rate the People and Process Pillars, and they produce ratings notes that are typically five to 20 pages long, not counting attachments. Then they take their proposals to ratings committees of senior researchers who question the analysts’ conclusions and evidence before voting on the pillars.
I’ve only hinted at the fund company side of this story, but it’s an important part to discuss. Each fund company handles manager changes differently. Let’s look at a few examples from the biggest to help illustrate the differences and how they inform our ratings.
Vanguard runs some bond funds and index funds in-house. I’ll focus here on its subadvised funds because they stand out. Some Vanguard funds have multiple subadvisors, and others have just one. Vanguard is a pretty patient manager of subadvisors, so don’t look for a bad year or two to lead to a firing. But a poor five-year record is another thing.
So is personnel turmoil. Vanguard hates to see subadvisors lose key managers or analysts, and it will sometimes fire them simply for that. That’s one of the strengths of the subadvisor model. You can fire a subadvisor and move on to a more stable firm rather than watch the struggling firm try to duct tape over its problems.
Vanguard also cares a lot about strategy. It doesn’t want managers veering off their established strategies because that shows a lack of discipline. But it can also create problems at a fund that might have three subadvisors chosen to deliver a certain style exposure and risk/reward profile. If, say, a relative value manager veers toward deep value in a fund that already has deep-value managers, Vanguard may make a change. Vanguard wants its subadvisors to have differentiated sources of excess return. That means it wants managers who are good at different things and have complementary styles.
Although Vanguard’s methods are clear in the big picture, I should note that it is typically tight-lipped about the reasons for particular manager changes. Vanguard wants all potential subadvisors to see the firm as a desirable partner, so it is careful not to say anything negative about a subadvisor that has been dismissed. Although Vanguard has largely been hands-off with Primecap- and Wellington-run funds, it has at times done a little more tinkering with a fund’s subadvisor lineup than I’d like to see.
Fidelity has worked to more clearly telegraph and smooth its manager changes, but it still faces greater challenges than many because it has a huge number of mostly single-manager funds.
Thus, each manager puts his own stamp on a fund. And less experienced managers often adjust their strategies as they go along based in part on what Fidelity’s in-house analysis suggests they are good at.
Let’s look at a couple of examples. Derek Janssen is back at the helm of Fidelity Small Cap Value (FCPVX) after the surprising departure of Clint Lawrence. Janssen ran this fund prior to Lawrence's tenure to good effect, so he has a relevant track record on this very same strategy. However, Jannsen remains at the helm over Fidelity Small Cap Discovery (FSCRX) and may just be filling in until a new portfolio manager is ready to step in. Thus, we we are holding the People rating at Average and the Analyst Rating at Neutral.
On the other hand, we maintained an Above Average People rating at Fidelity Emerging Markets (FEMKX) when John Dance took over in October 2020 after a transition period. Fidelity named him as successor and comanager in February 2019 because manager Sammy Simnegar was leaving to take over Fidelity Magellan (FMAGX). We liked Dance’s track record at Fidelity Pacific Basin (FPBFX) and Fidelity Emerging Asia (FSEAX) where he outperformed both funds’ benchmarks. We have an Average Process rating on the fund while we watch to see how Dance adapts to his broader mandate.
At American, equity funds have multiple managers, each of whom runs a sleeve independently of the others. The funds often have an analyst-run sleeve that typically houses 20% of assets. Thus, one departure or addition rarely alters a strategy’s profile in a big way. The analyst-run sleeve often serves a talent pool for American’s next generation of diversified money managers. American tends to appoint promising analysts to this role without publicly naming them until their assets increase to about 5% of the overall strategy’s. By the time American names a first-time manager, that person often has 15 to 20 years of industry experience, including two to four years as a money manager on the strategy in an undisclosed capacity. The firm chooses new managers who fit the fund’s style profile and sometimes brings a fund back in line with that profile if a departing manager leaned to one end or the other of the mandate.
Occasionally we see a little more activity than usual, such as at American Funds AMCAP (AMCPX), whose eight-person management team had two departures and two additions in 2020. The two new managers, Jessica Spaly and Cheryl Frank, each came with 20-plus years of industry experience. They became undisclosed portfolio managers on the fund three and two years prior, respectively, and American Funds’ decision to name them publicly in October 2020 suggested their results over those periods were both strong and complementary to the other portfolio managers’, clearing the way for them to manage a greater share of the fund’s assets. So, with two veteran investors coming on board, we felt a Fund Analyst Note was enough to signal that we were not changing our High People rating.
T. Rowe Price
As the T. Rowe Price Blue Chip Growth example illustrates, we think highly of the firm’s investment professionals and often give its new managers Above Average ratings depending on their experience level. However, managers who build a following sometimes jump to set up their own firms, and we occasionally see rather abrupt manager and analyst departures. At T. Rowe Price New Horizons (PRNHX), for instance, Henry Ellenbogen left with an associate manager and two analysts in order to start his own firm. Those kinds of moves make us more inclined to downgrades.
Initially, we lowered T. Rowe Price New Horizons’ Process rating to Average and kept the People Pillar at Above Average because Joshua Spencer had impressed at T. Rowe Price Global Technology (PRGTX). We lowered the overall rating to Bronze from Gold. Ellenbogen was as adept with private placements as he was with publicly traded names, and we weren’t sure if Spencer would prove himself as adroit.
We’ve become more comfortable with Spencer’s approach and raised the Process rating to Above Average and Analyst Rating to Silver in January 2021. Spencer had 6% of the fund in private equity at last check, and he’s executed well in his short tenure.
Our ratings are forward-looking and don’t lean too heavily on prior managers’ records. Most often we hear surprise when we downgrade a fund with strong performance but with a new manager who doesn’t have much of a track record. And we might raise our rating faster than others expect when a weaker performer has been given a strong team or manager. It really comes down to if you are more attached to a fund’s shell (its name and past returns) or its engine (its manager and strategy.)
Russel Kinnel does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.