Excerpt
I. Table of Contents
I. Table of Contents
II. List of Tables
III. List of Figures
1 Introduction
2 Theory
2.1 Classical decision making theory
2.2 Behavioral decision making
2.3 Group shift theory
2.4 Diversification of opinions theory
3 Literature
3.1 Differences in investment behavior
3.2 Performance
4 Empirical Study
4.1 Data and methodology
4.2 Risk and performance evaluation
4.2.1 Risk taking
4.2.2 Performance evaluation
4.3 Results
4.4 Critical review
5 Conclusion
IV. References
II. List of Tables
Table 1: Coefficients for the risk evaluation
Table 2: Coefficients for the performance evaluation
III. List of Figures
Figure 1: Evolution of Mutual Fund Management Structures from 1992 - 2015
1 Introduction
"Single-manager funds are more like practices - law firms, doctors' offices, etc. - while multi-manager funds are more like corporations. You can do well with either one, but there are clear trade-offs."1
When looking at the proportion of team-managed and single-managed mutual funds, it is observed that team funds have increased at the cost of single-managed funds. Thus, from 1992 to 2015, within all mutual funds, team-managed funds increased from 12% to 57%, while single-managed funds decreased from 88% to 43%. A similar development can be seen in the change of the management structure of a fund in Figure 1: A total of 553 mutual funds, which were previously managed individually, switched to a team fund, whereas only 317 funds changed from a team-managed fund to an single-managed fund.
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FIGURE 1 Evolution of Mutual Fund Management Structures from 1992 to 2015
Figure 1 shows the percentage of single-managed and team-managed funds in the sample of 19,976 observations from each year from the Center for Research in Security Prices (CRSP). The left-hand-side vertical axis represents the percentage of single- and team-managed funds out of the total funds in the sample each year. The right-hand-side vertical axis represents the total number of changes in management structure for each year. Single to team means, that one fund had a single-management structure in the previous year and decided to change it in the observed year. The analogous case is valid for Team to single. The horizontal axis represents each year included in the time-span of 1992 - 2015.
A crossover in the proportion of teams after the global financial crisis in 2008, in times when risk reduction by diversification began to gain in importance, is clearly observable. Thus, it should be in the interest of mutual funds to possess sufficient management diversity to reach an adequate niveau of diversification. As argued by Tom Stevenson, the investment director of Fidelity International, besides gender diversity, diversity in cognition, education and mindset represent a great strength.2
Research on the mutual fund industry indicates some differences in the investment behavior between team-managed and single-managed mutual funds. Especially concerning teams, different theories of decision making can be found, resulting in different investment styles and performance levels.
The aim of this study is to identify differences in investment behavior - and in particular the special case of a team's decision-making process - as well as possible performance indicators. The research results to be presented should be used as guidance in selecting an appropriate management structure for the mutual fund industry. Before addressing the differing investment behaviors of the two management structures, the special dynamics that can operate within a team in decision making have to be examined. For this said purpose, the relevant literature provides some conflicting theories on decision making.
2 Theory
In the subsequent chapter, the classical decision theory and the behavioral decision theory will be compared. Furthermore, the group shift theory and the diversification of opinions theory will be introduced for a greater insight on the behavioral decision theory. This comparison will later be used to help explain differences in the investment behavior and the performance of mutual funds depending on their management structure.
2.1 Classical decision making theory
Zeckhauser states that classical decision theory derives from the rational choice model. This model holds four main assumptions. Firstly, all states in the world are known and in a steady state. Secondly, all resources are in continuous allocation. Following which in the third assumption the existence of clear alternatives and their outputs is considered. The last assumption implies that the pricing of sold goods and commodities is subject to arbitrage.3 These assumptions underlie the utility theory and are based only on the outcome of the alternatives.4
The utility model by von Neumann et al. (2004) suggests that the overall costs and benefits of a specific choice of alternatives are set in a utility function.5 In a further version of this model, the selected alternatives are defined as the maximization process of the ideal utility maximizer, which includes the most optimal decisions.6 In this case, an ideal utility maximizer is either an individual decision maker without any type of influence in his/her decision or a team of decision makers which has to reach a compromise before reaching a final decision.7 Consequently, all individuals would have the same utility function, meaning the ideal utility maximizer would reach to the same decision.8
2.2 Behavioral decision making
The contrast to the classical decision theory forms the behavioral decision theory. For this, human factors are integrated into the decision making process, in which the classical decision theory's assumptions are modified. Contrary to the utility theory, this theory is based on the bounded rationality model by Simon, which describes decision making as a process guided by aspiration levels.9 Zeckhauser adapts the previous assumptions given in the classical decision theory. This means all market states are not in a steady-state anymore, but are changing constantly, they are unique, and have to be recognized first. Secondly, there is no longer a continuous allocation of resources, but rather a discrete distribution of them. Furthermore, the assumption applies that alternatives must first be identified, its results being only moderated by formulation and implementation of the strategies, and that price setting is not bound to arbitrage but is negotiable. The most important opposing point of the two theories is the last, following assumption. This one says, that values, ethics and culture can influence perception of risk and uncertainty.10 Unlike the classical decision theory, behavioral decision theory does no longer refer only to the outcome of the alternatives, but to the gains and losses that arise from the final decision.11
In particular, there exists special effects during decision making within teams. Burnstein/Vinokur addressed the phenomena of risky shifts and group polarization in their studies on single members' behavior in a team decision making situation, suggesting that teams can fall into these effects.12 For a more detailed insight on the behavioral decision theory, these phenomena will be explained next.
2.3 Group shift theory
The group shift theory arises from the social comparison theory. The latter theory was first proposed by Festinger and has provided a persistent explanation of individual behavior in groups ever since.13 It is based on the idea that individuals evaluate themselves relative to others and strive to be accepted by each other.14 Such normative influences result in adapting to what the socially accepted opinion of the group is. This effect of adaption is called upward social comparison, implying that individuals will only express an opinion if it is accepted particularly by the dominant members of the group.15 This creates an enhanced self-perception, as the individual possesses the strive for being similar to the dominant person.16
This adaptation leads to two reinforcing effects: (1) By creating an informal hierarchy even without a formal hierarchy, individuals adapt to the dominant person in the group. In such hierarchies, whether formal or informal, individuals with more extreme views are more likely to achieve higher membership status within the group (Gibb, 1947).17 This offers a possible explanation for favoring individuals holding more extreme views (Jellison & Davis, 1973).18 Accordingly, the dominant person's opinion is already predetermined for the group. (2) Also, by the creation of feedback loops, it is possible for more extreme views to become prevalent than before. This comes from seeking to conform the individual opinion more than other team members (Brown, 1974).19 For example, if the initial opinion of the group has been to overweight investment in the IT industry, individuals tend to advocate a stronger weighting in the IT industry than they had before.
In summary, this theory argues for a more extreme tendency in decision-making behavior for groups when compared to individuals. However, there is also evidence for an opposite effect observed in groups, which is discussed below. For this purpose, the diversification of opinions theory is introduced in the following.
2.4 Diversification of opinions theory
Because team members can have different views, the group's final decision would not always have to consider the opinions of all individuals. Actually, the sum of all individual decisions should form a compromise which is reflected in the group decision (Sah & Stiglitz, 1986).20 The diversification of opinions theory implies that the team decision should represent the average of all opinions and thus reflect a more moderate decision of the whole team relative to the single opinions.
The greater the variation among opinions, the more the diversification of opinions theory should be highlighted.21 As one reason for this assumption, for example, team members differ in their demographic characteristics, tenure, and education.22
For instance, younger managers have higher risk attitudes due to their higher risk of being fired.23 Thus, with respect to the final decision, in a group with very young and very old managers, it is possible that the higher risk preference of the younger managers and the lower risk preference of the older managers balance each other out to finally result in a mid-risk decision.
3 Literature
Referring to the above theoretical explanations, different implications for the decision-making process within teams can be examined. This process reflects differences in investment behavior and performance between team-managed and individually managed funds. In the following, the existing contextual literature is reviewed.
3.1 Differences in investment behavior
In this section, possible differences in investment behavior between team funds
and single funds are revealed with findings from economic and psychological literature.
One of the points made is the gap between mutual funds with a team and single fund management structure in their comprehension and coping of information. A study on the differing learning and adaptation process of teams and individuals is offered by Cooper/Kagel.24 The results from the psychological points of view show that strategic interactions develop better in teams than in individuals. The more difficult it is for subjects to learn the strategic game, the more the superiority of team play increases.25 As a result, teams outperform the norm for learning probabilities compared to individuals in the most challenging games.26 In the mutual fund industry, this may imply that teams are more capable of handling more complex and larger tasks that are relevant to their decisions. The findings of Baer et al. show that teams are larger in fund size and hold larger funds of more total net assets than single managers and are equally responsible for funds that require a broader expertise, such as the balanced fund or global fund segments.27 Such evidence supports the assumption that teams are hired for more complex and larger tasks.
When studying individuals and teams with respect to their extremity in investment style and risk attitude, the literature offers contrasting statements. The idea of averaging opinions of all individuals in a group decision was previously introduced by Moscovici and Zavalloni.28 Another study by Adams and Ferreira elaborates on the variability in terms of group decision making, the results of which provide some evidence for lower extremity in group decisions.29 Even though the latter study was not conducted in a professional context within the mutual fund industry, it shows a clear effect of the diversification of opinions theory. However, the different behaviors in different management structures should not be considered for generality, as the quantitative and objective data collection for team behaviors is more complex in other contexts of the world than in the mutual fund industry.30 Nevertheless, it can be concluded by this assumption that teams make lower extreme and less volatile decisions than single managers in the longer run.31
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1 Cf. DeChesare (2021).
2 Cf. Jefferies (2017).
3 Cf. Zeckhauser (1986) p. 442.
4 Cf. Kameda/Davis (1990) p. 56.
5 Cf. Forgó (2004) p. 76 f.
6 Cf. Kahneman/Tversky (1984) p. 341 – 350.
7 Cf. Hollenbeck et al. (1998) p.269 – 280.
8 Cf. Arrow (1986) p. 389.
9 Cf. Selten (1999) p. 2.
10 Cf. Zeckhauser (1986) p. 442.
11 Cf. Kameda/Davis (1990) p. 56.
12 Cf. Burnstein/Vinokur, 1977 p. 315 – 330.
13 Cf. Festinger (1954) p. 117 – 140.
14 Cf. Festinger (1954) p. 117 – 119.
15 Cf. Baron et al. (1971) p. 446 – 455.
16 Cf. Suls et al. (2000) p. 219 -237.
17 Cf. Gibb (1947) p. 267 – 284.
18 Cf. Jellison/Davis (1973) p. 435.
19 Cf. Brown (1974) p. 468 – 470.
20 Cf. Sah/Stiglitz (1986) p. 716 – 727.
21 Cf. Bär et al. (2011) p. 362.
22 Cf. Baer et al. (2007) p. 1 – 22.
23 Cf. Chevalier/Ellison (1999a) p. 391.
24 Cf. Cooper/Kagel (2005) p. 477 – 508.
25 Cf. Cooper/Kagel (2005) p. 502.
26 Cf. Cooper/Kagel (2005) p. 502.
27 Cf. Baer et al. (2005) p. 3.
28 Cf. Moscovici/Zavalloni (1969) p. 125.
29 Cf. Adams/Ferreira (2010) p. 884.
30 Cf. Bär et al. (2011) p. 360.
31 Cf. Sah/Stiglitz (1991) p. 289 f.