A number of financial publications believe that when a mutual fund manager leaves a fund, fund investors should immediately become concerned. These scare tactics help sell publications and software. The reality is quite different.
With certain categories of mutual funds, government securities, short-term bonds, and index funds, a change in management likely means nothing. These types of funds have very narrow parameters that must be followed—whoever oversees such portfolios has very little latitude when it comes to making changes. Other funds have a very high R-squared, which means the fund is closely mimicking an index and is therefore quite similar to an index fund with regard to risk and return.
R-squared measures the return correlation of a mutual fund to an index, S&P 500 in the case of stocks and the Barclays Aggregate Bond Index for bond funds. R-squared ranges from 0 to 100; if a fund has an R-squared of 90+, it is very similar to an index and management has very little impact on returns or risk. One could also argue that an R-squared of even 75-80 is quite high.
When A Manager Leaves
Advisors often wonder what to do when a favored mutual fund manager leaves a fund or simply retires. According to studies, when a new manager steps in, subsequent returns are somewhat mixed. For example, an August 2012 study from the University of Rochester shows there is, overall, no difference in returns. However, funds that trailed their benchmarks tended to perform better after the management change—an enhanced performance may likely be due to any fund’s returns that revert to the mean after periods of ups and downs. This also coincides with what happens when a manager of an above-average performing fund leaves —returns tend to decline (reversion to the mean).
Advisors who wish to take a different approach to a manager departing should consider the following:
 Is the departing manager a core driver for fund performance?
 How closely did the new manager work with the departing manager?
 How much do sector weightings change with the new manager?
 How many of the 10 largest holdings change with the new manager?
 Has the fund’s overall turnover rate changed much?
Over the past decade (2003-2012), 57% of active mutual fund managers failed to beat their benchmark indexes. For 2011, 84% underperformed (source: S&P).
According to Morningstar, “tracking error” is the amount a fund’s returns that veer from its benchmark. For the 12-month period ending August 31, 2012, tracking error for bond funds was 2.2% (vs. 2% for the same period ending in 2011). For the 5-year period before the 2008 meltdown, the deviation averaged 1.4% for a 12-month period.