Four questions to ask when a manager leaves

Following the recent announcement of all-star European manager Tim McCarron's imminent departure from Fidelity, we revisit some key questions that you should ask of your fund when a manager leaves.

When the manager of your fund leaves, it's natural to be concerned. After all, you may have bought that fund specifically to gain access to that manager's knowledge and expertise. If he or she goes somewhere else, the fund you own could become different from what you bought. That's not always a bad thing; although some manager changes are a negative for shareholders, in other cases they improve the fund or at least maintain the status quo.

The big question thus becomes, how can you tell whether the impact of a manager change is good, bad, or neutral? It's impossible to know for sure, of course, but there are various things to look for that can usually give you a pretty good idea of what to expect. Here are some of the questions that Morningstar fund analysts ask ourselves when a manager departs. Getting the answers to these questions should help you decide whether a fund is worth holding on to once it's under new management.

1. How important was the old manager to the fund?
Not all managers are equally important to the funds they run. Some are absolutely central and difficult to replace, while the nature of other funds makes their managers less crucial, even if they are very good. If a key manager leaves, it's more likely that you'll want to get out.

2. Will there be a smooth transition?
Another factor to consider is the smoothness of the transition from the old manager to the new. In a worst-case scenario, a fund manager leaves abruptly, with no advance warning, and perhaps takes along all or most of the fund's analysts and other support staff, leaving the fund provider scrambling to find a replacement. Such disruptions greatly increase the uncertainty around a fund. On the other hand, gradual, well-planned transitions where the fund doesn't miss a beat are nice to see and often make it worth investors' while to stick around. Some fund shops are better at this sort of thing than others, so it's a good idea to be aware of how a shop has handled changes in the past.

3. Will the fund's strategy change?
It's disruptive enough when a manager leaves and is replaced by a new one, but the question marks multiply when a manager change is accompanied by a complete overhaul of the fund's strategy. It's not impossible for such wholesale changes to be positive, but experience has made us very sceptical in most cases.

The problem is that such strategy changes make the fund into something new that may no longer suit the needs of the shareholders who bought it. If you buy a large-value fund to play a specific role in your portfolio, and it suddenly changes into a small-growth fund, your portfolio becomes skewed in ways you didn't intend. Also, a wholesale overhaul of a fund's portfolio can sometimes result in capital gains for the fund and a large taxable distribution for shareholders. Thus, even apart from any problems with the quality of management, a major strategy change should make you think long and hard about whether to sell a fund.

4. What is the new manager's track record?
Ultimately, the most important factor to consider in evaluating a manager change is the quality and track record of the new manager. Bringing in an accomplished manager can make a mediocre fund look good, or a good fund look even better, while a new manager with a so-so record, or no record at all as a fund manager, usually gives us pause. This article provides further information on types of managers and fund management structures. Here at Morningstar we're currently working on improving our fund manager data to enable you to search our site for a particular name and read up on their past performance. In the meantime, our qualitative research reports contain a 'People' section that provides a brief yet informative overview of those at the fund's helm. Take a look at our recent report on Fidelity European, for example (the 'People' information can be found on the second page of the PDF report).

Our Adviser Workstation and Morningstar Direct products, aimed at financial advisers and institutional investors respectively, also contain additional fund manager data.

In short
Evaluating fund manager changes is no simple task. It's impossible to know for sure how a change will work out, but it's usually possible to get a pretty good idea of what to expect. When deciding what to do, it's always a good idea to keep potential tax consequences in mind. If you sell, you may be liable for capital gains taxes, so it's important to find a replacement fund that's good enough to overcome those potential taxes. In many cases, the best course of action may be to stay put for a while to see how well the new manager does and sell only if you've lost confidence. Ultimately, the decision is up to you, but having the answers to the questions that we've been discussing should make that decision easier.

A previous version of this article, written by David Kathman, Morningstar fund analyst, appeared on Morningstar.com in 2007.