STARTED FROM THE BOTTOM

Fund managers who come from poor backgrounds are better investors than rich ones

The next time you are choosing which fund to invest in, make sure the manager was not born into privilege.

A recently published study (pdf) found that investment fund managers from poor backgrounds deliver better returns than those born rich. Of the hundreds of managers the researchers studied, those from the bottom 20% of households in terms of wealth outperformed managers from the top 20% by over 1% per year.

The researchers, Oleg Chuprinin of the University of New South Wales and Denis Sosyura of the University of Michigan, think this is due to the high barriers of entry to getting a finance job. They believe that only the most skilled people from poor backgrounds become fund managers, while those born rich find it easier to land a job in the industry because of inherited status and networks.

Generating this result took some impressive data sleuthing. In order to obtain the demographic and fund performance data needed to conduct the study, Chuprinin and Sosyura combined historical information from investment research firm Morningstar, the Lexis Nexis information database, and individual records from the US Census. All together, they were able to collect detailed data on the family wealth and performance of nearly 400 managers of US-based funds active from 1975 to 2012.

After collecting the data, the researchers began by assessing whether fund managers born into different wealth quintiles performed better or worse than the market. (Outperforming the market is known as generating “alpha.”) Without accounting for any other differences, fund managers born into the top quintile of family wealth produced alpha nearly 0.8% per year lower, on a risk-adjusted basis, than their counterparts that came from the least wealthy quintile.

When the researchers examined the data in more detail, the difference in performance became even starker. Managers from wealthy backgrounds were more likely to have gone to a prestigious university and have a PhD, which are both associated with higher returns. After controlling for the education disparities between the rich and poor, the researchers found that the performance gap between the most and least privileged grew to over 1.2%—with much of the effect driven by the poor performance of managers who came from the wealthiest families.

Chuprinin and Sosyura not only investigated fund performance, but also tracked the career trajectories of managers in their sample. It turned out that to get promoted, strong performance was a much more important factor for managers from poorer households. Those born rich might get promoted even if their performance was bad, while those born into more challenging circumstances had to be exceptional to get ahead.

Timothy Taylor, an economist and editor of the Journal of Economics Perspectives, was struck by the findings. “On practical grounds, there’s no particular reason to believe that the underlying takeaway from the paper applies only to mutual funds,” Taylor wrote on his blog. “When those who face higher barriers to success manage to overcome those barriers in any occupation, it may often be a sign that their competence level is not just high, but exceptionally high.”

In other words, in any competitive industry, those who start from the bottom are probably the very best when they reach the top.

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