Holly Black: Welcome to Morningstar. I'm Holly Black. With me is Thomas DeFauw. He is on the Morningstar Manager Research team. Hello.
Thomas DeFauw: Hi, Holly.
Black: So, we're going to be talking about a common dilemma for investors, one that I think gets people in a bit of a muddle sometimes, what happens when your fund manager leaves the fund. Should we start with some of the common reasons that a manager might leave a fund?
DeFauw: Sure. Well, there are several reasons why managers leave their posts. Some may receive a compelling offer by a competitor, while others are forced to resign due to poor results. Whatever the reason may be, it's important for each investor to take notes. After all, it is the fund manager that is responsible for the strategy, for the security selection and the portfolio construction.
Black: So, the key question is, what should I do if my fund manager leaves. Should I just sell?
DeFauw: No, not necessarily. So, although it may be tempting to sell, especially when a fund manager has a good track record, it's important not to panic. So, at Morningstar, we see the departure of a key person as a red flag. But before we would downgrade a strategy, we need to figure out the true impact. First, we want to assess the situation prior to the manager's departure. So, we ask ourselves questions like was he or she managing this fund on his own or was it more like a team approach. In case a manager relies on the team of co-managers and analysts, we want to know more about the size, about the quality, the stability, as well as the role of each member on that team. If the support plays an important role and decisions are taken by a team rather than one person, the manager's departure may actually not have a major impact on the overall strategy. If on the other hand, he or she was running the fund on his own like the so-called star manager, a departure would obviously be a more serious threat.
Black: I mean, a term we quite frequently hear is succession planning. So, when a manager knows a couple of year years out that he's going to leave, he can start a sort of gradual handover to the next manager. And it's that sort of continuity that investors want when a manager leaves, right?
DeFauw: That's definitely correct. So, the next step in our process would be to evaluate new fund manager. Is he or she an experienced manager that is perhaps known to us already or has the firm decided to give the opportunity to a young, talented manager to prove himself? So, Morningstar analysts would look at several criteria when we evaluate that new manager such as the relevance of their experience. Let me give you an example.
A successful dividend investor with a 20-year track record may not be the best person to manage an equity growth fund. Although both strategies invest in stocks, the approach is very different. Also, what's interesting to know is whether a new manager is an internal or an external hire and that person has a track record. In some asset managers, analysts that get promoted to portfolio manager after some years and although that may be very good in the sense that they know the organization and the philosophy well, managing money requires a different skill set. And finally, it's important to figure out if this new manager style fits the strategy. If not, we can expect perhaps some changes in the investment approach. If the portfolio would change in such way that the strategy no longer fulfills the investors' objectives or fit within the portfolio, that may actually be a good reason to sell.
Black: And for a Morningstar analyst a fund manager departure often means that the fund's rating is put under review and it can be subject to an upgrade or a downgrade? Can you give us an example of where that's happened?
DeFauw: Yes, absolutely. Let me perhaps give you a more extreme example. But I think it illustrates well what we just talked about. In November of last year, NN Investment Partners saw almost its entire emerging market debt team leave to a competitor. When such event happens what Morningstar analyst would first do is place the strategy under review in order to assess the situation more in depth and then decide if the Morningstar Analysts Rating is still appropriate. So, in this case, it was decided to downgrade the fund to a Negative rating. Although NN brought in a team of interim portfolio managers, the lack of relevant emerging market experience put the fund's process at risk and also increase the workload for those managers. So, since then, the company has started rebuilding the team and has hired several analysts and portfolio managers. And although we see this definitely as an encouraging step, it takes more to rebuild confidence.
Black: Thomas, thank you so much for your time. For Morningstar, I'm Holly Black.
