Are You Smarter Than a CFA’er?

Oguzhan Dincer
Illinois State University
odincer@ilstu.edu

Russell B. Gregory-Allen∗
Massey University
r.gregory-allen@massey.ac.nz

Hany Shawky
SUNY, Albany
h.shawky@albany.edu

PRELIMINARY PAPER - IN PROCESS


Corresponding author

Electronic copy available at: http://ssrn.com/abstract=1458219

 Are You Smarter Than a CFA’er?

Abstract

Several studies have examined whether a manager having an MBA or CFA leads to superior
portfolio performance. However, these studies have yielded mixed conclusions. A possible
reason is that most have considered only MBA or CFA alone, and most have not controlled
for managers’ style targets. We examine MBAs and CFAs together, controlling for market
conditions and style targets. We find that the CFAs do add value, but even more significantly
(especially in light of events in recent months) – CFAs reduce and MBAs increase Tracking
Error.

PRELIMINARY PAPER - IN PROCESS

Electronic copy available at: http://ssrn.com/abstract=1458219

 Are You Smarter Than a CFA’er?

Intro
Researchers have long been interested in the agency aspect of portfolio management, relating
manager characteristics to portfolio performance. Human capital theory, as well as common
sense, implies that managers with greater ability should, at least in the long run, have
portfolios with better performance than "average".

A natural extension of this is that managers with better education ought to show better
performance. Common forms of education for mutual fund portfolio managers are formal
university training resulting in an MBA, disciplined self-study culminating in a certification
such as the CFA, and accumulated experience from the School of Hard Knocks.
We examine whether there is a discernable impact of the type of education managers have on
the portfolios they manage. We find that after adjusting for both risk models and portfolio
style targets, there is no difference in returns for any of these education levels. However,
CFA's have portfolios with substantially lower risk, and MBA's may actually increase risk.
Aside from casual interest, these findings might have implications for how MBA’s are taught.

The research in this area has taken primarily two forms: 1) Do CFA’s add value? and 2) Do
MBA’s add value? The MBA stream has also had interest in relating the “quality” of the
MBA granting school to the portfolio performance. A few have included both MBA and
CFA, but have also included several other manager characteristics, such as gender and age.

Shukla and Singh (1994) and Switzer and Huang (2007) find CFA’s outperform other
managers, while Golec (1996) finds MBA’s do. Chevalier and Ellison (1999) and
Gottesman and Morey (2006) find that MBA’s from schools with higher average test scores
perform better. Boyson (2002) finds that both CFA’s and MBA’s deliver negative
performance.

Electronic copy available at: http://ssrn.com/abstract=1458219

Literature review
From the previous literature, it is difficult to discern a pattern. Some of the studies have
looked only at CFA, some only at MBA; some have used only returns in excess of the tbill,
others in excess of a benchmark, though most have at least used CAPM, and some have used
Carhart alphas.

Shukla and Singh (1994), using CAPM alphas over the period 1988-1992, find that portfolios
with at least one CFA perform better than others, but with higher risk, and not in every style
category.

Switzer and Huang (2007), examining 1004 small and mid-cap funds, with variously defined
returns for 2005, consider performance impact of several manager characteristics - MBA,
CFA, gender, age and experience. They find CFA's deliver better performance, but tenure,
experience, and gender do not matter.

Golec (1996) considers age, job tenure, and MBA. With a sample of 530 funds over the
period 1988-1990, he models CAPM controlling for style objectives. He finds out-
performance from younger mangers with longer tenure, and from managers with MBA's.

Chevalier and Ellison (1999) examine impact on performance of age, job tenure, and average
SAT of the manager’s undergraduate school. They examine both returns in excess of a
market composite, and CAPM (Fama-MacBeth) alphas. They find higher return from MBAs,
but entirely due to higher risk, younger managers do better, and managers from
(undergraduate) schools with higher SAT's have higher returns, after controlling for
risk/expenses, etc.

Gottesman and Morey (2006) extend Chevalier and Ellison, examining 518 Funds over the
period 2000-2003, using Jensen, Carhart, and conditional alphas. They find that the average
GMAT of the manager's MBA program is positively related to portfolio performance. They
further find that CFA and PHD are unrelated to performance.
Boyson (2002) examines 288 hedge-funds over the period 1994-2000, considering primarily
the effect of MBA and tenure, but also considering CFA, PHD, and age. Defining returns in
two ways (excess of Tbill and excess over a style benchmark), she finds that MBA and tenure
are both negatively linked to performance, and mixed evidence that CFA is negative. She
also finds that MBA’s have more volatility

What is missing from the above is a single study that directly compares the CFA and MBA,
controlling for risk and style factors. This study does that, examining Jensen alphas to
compare our results with previous studies, and then use Carhart 4-factor alphas, to capture a
more complete risk model. We also control for style targets employed by the managers.

From the above it is clear that age, investment experience and/or job tenure might also play a
role. Therefore, we consider this as a third educational alternative – a graduate of the School
of Hard Knocks. So, we compare in a risk and style controlled model, the performance
benefit of three different educational methods – CFA, MBA, and Experience.

Data Description
The Plan Sponsor Network Database (PSN), developed and marketed by INFORMA, reports
on how individual managers manage their portfolios with respect to both investment style and
the types of models used. In addition, PSN reports a wealth of manager specific information
not covered by other sources, such as Morningstar. In particular for this study, PSN reports
on education type and level for all the managers associated with a given fund.

We consider open US equity funds, AIMR compliant, which existed in January 2004. We
eliminate funds where the fund family has less than $100 million AUM, and funds with less
than $1 million. We further eliminate any fund that has less than 1 year of monthly returns.

Each fund has potentially multiple managers. In our final sample of 918 funds, over 700 list
more than 1 manager. For each fund, there is a Primary manager, what PSN calls the Key
Portfolio Manager (KPM), and as many as 9 other managers, though the maximum in our
sample is 6. For each manager, there is information on age, professional designation,
graduate degree, etc. In some cases, the professional designation column was blank but the
manager's name included 'CFA' -- in such cases, we considered that manager to be a CFA.
For graduate degree, often the listing was unambiguously 'MBA'. However, sometimes it
was entered as 'Master', and sometimes as 'Master-Finance' -- in the latter case, we considered
that manager as MBA, in the former we did not. In the few cases when graduate degree listed
PHD, it rarely indicated a major (and sometimes was clearly not finance related). For this
reason, we do not consider PHD.

In our final sample, of the KPM's 360 are CFA's, and 255 have an MBA. Of the Funds, 423
have at least 1 CFA on the team and 329 have MBAs. We examine monthly fund returns, net
of fees, for the period 2004 – 2007.

Models

Previous literature has examined fund performance both in raw returns and adjusted for a
model like CAPM. We consider further risk adjustment models, and in addition control for
fund size and management styles.

In order to examine the marginal performance of individual fund managers that is due to the
use of a given investment process, we use a two stage procedure. First, we estimate
performance alphas (Jensen and Carhart) using CAPM, and the Carhart 4-factor model
(1997) as follows:
(1) Ri = α Jensen ,i + β 1 RB + ε i

(2) Ri = α Carhart ,i + β 1 RB + β 2 SMB + β 2 HML + β 3 MOM + ε i

where:

Ri is the return for fund i, in excess of fees and the 90 day US Tbill rate
RB is the return on the S&P500, in excess of the 90 day US Tbill rate
SMB, HML and MOM are the Fama-French and Carhart factors
And in a second stage, we use these alphas in a cross-sectional dummy variable regression
with control variables to estimate the marginal contribution of the various factors to
performance.1 We define dummy variables for each of our potential classifications:

CFA = 1 if the KPM has a CFA

MBA = 1 if the KPM has an MBA
AnyCFA = 1 if at least one manager has a CFA
AnyMBA = 1 if at least one manager has a MBA

And
KPMexp = years investment industry experience of the KPM

For our control variables, we use the log(fund size), and 3 more dummy variables for the
style target of the fund, Growth, Value and Core (there are several other potential targets
identified by PSN, making up our "other" group for the regressions).

So, our regression for the type of education for the Primary Manager is

α i = γ 0 + β 1Gro + β 2Val + β 3Cor + β 4 ln( Assets) + β 5 CFA +

(3)
β 6 MBAi + β 7 KPMExpi + ε i

To determine if there is an influence of CFA or MBA from having one of these on the team,
we estimate:
α i = γ 0 + β 1Gro + β 2Val + β 3Cor + β 4 ln( Assets) + β 5 AnyCFA +
(4)
β 6 AnyMBAi + ε i

Finally, equally important as generating positive alpha is controlling risk. A common metric
in the industry is to control risk with tracking error. Although there are some competing
definitions, the most commonly used in industry is the standard deviation of the difference
between portfolio returns and the benchmark. In our case, that is

1
We also examined alphas from the Fama French 3-factor model (1993), with qualitatively the same results as
the Carhart alphas.
 di ,t = Ri ,t − RBi ,t ,t
(5)
TEi = std ( dt )

Obviously, a fund that matches the benchmark exactly will have a TE=0, and the farther
away the fund is from the benchmark the higher the TE. Also obvious is that in order for a
manager to outperform the benchmark, he or she must have non-zero tracking error. Further,
if a fund does not use the SP500 as their benchmark, defining TE this way will result in a
potentially higher TE. However, examining funds cross-sectionally as we are, unless there is
a systematic difference in CFA/MBA with respect to the benchmark used, our analysis will
reveal any relationship between risk and education.

So, to model the tendency for this risk exposure attributable to type of education, we estimate

TEi = γ 0 + β 1Gro + β 2Val + β 3Cor + β 4 ln( Assets ) + β 5 CFA +

(6)
β 6 MBAi + β 7 KPMExpi + ε i

and for the “any manager” effect:

TEi = γ 0 + β 1Gro + β 2Val + β 3Cor + β 4 ln( Assets) + β 5 AnyCFA +

(7)
β 6 anyMBAi + ε i
Preliminary Results

Impact on return:
First, we consider the impact on risk-adjusted performance, similar to other studies. When
we simply regress the Jensen alphas against MBA and CFA dummies, we get results similar
to previous studies – MBA’s add value, and CFA has no impact.
Coef T
int 0.1686 9.9
MBA 0.0882 3.02
CFA -0.0295 -1.1

R2 0.01
N 916

However, this does not take into account the fact that different types of managers have
different objectives and styles. When we control for size and managers’ target dummies
(modelling equation 3), the significant results for MBA and CFA vanish:

Coef T
int 0.2891 6.23
GRO -0.3026 -8.17
VAL 0.1549 4.06
COR -0.0851 -2.09
Log Size -0.0068 -1.12
MBA 0.0253 0.98
CFA 0.0172 0.73

R2 0.25
N 912

In the current study, we focus on Carhart alphas, due to the more comprehensive accounting
for market conditions that provides, and we estimate our models both with and without the
control variables with Ordinary Least Squares (OLS).

We consider both Any MBA or Any CFA – meaning that there is some manager on the team
with that designation, whether the Key portfolio manager has such a designation, and how
long the Key Portfolio manager has been in the investment industry. We find ( see Table 1 )
that none of these education elements has a significant impact on style and market adjusted
return.
Impact on risk:
However, just as important as alpha is risk. When we model Tracking Error, the story gets
even more interesting. Whether we consider only the Key Portfolio Manager or any manager
on the team – CFA’s reduce TE and MBA’s increase TE. Again, experience does not have
much impact on TE (see Table 2).

This is a potentially very revealing result -- it suggests that business schools are teaching
MBA’s to create risk. The reason for this is not immediately obvious, but a compelling
possibility is that managers, knowing the distribution of year end bonuses is asymmetrical,
intentionally increase TE to improve the odds of a big bonus. With the high standard CFA’s
attribute to ethical behaviour, perhaps they are less likely to take that path.

Conclusions
In this preliminary study, we have found compelling evidence that MBA's add risk to a
portfolio, whereas CFA's reduce it, and Experience has no impact. However, a limitation of
this study is that we have used a common benchmark, the SP500, for all funds.
In the revised version of the paper, we will use the benchmark as used by each fund, and
allow that benchmark to change over our estimation period.
Table 1. Carhart Alpha

Carhart Alpha Carhart Alpha Carhart Alpha Carhart Alpha

AnyCFA 0.000 0.021

(0.01) (1.05)
AnyMBA -0.005 -0.027
(0.26) (1.28)
CFA 0.023 0.03
(1.15) (1.07)
MBA -0.001 -0.001
(0.04) (0.05)
KPMexp -0.001
(0.91)
Growth -0.263 -0.25
(5.87)*** (6.44)***
Value -0.075 -0.07
(1.71)* (1.74)*
Core -0.146 -0.15
(3.28)*** (3.52)***
lnmnsize 0.012 0.005
(2.16)** (0.86)
Constant -0.083 -0.005 -0.094 -0.013
(6.02)*** (0.11) (6.97)*** (0.26)
Observations 916 912 916 558
R-squared 0.00 0.11 0.00 0.09
Robust t statistics in parentheses
* significant at 10%; ** significant at 5%; *** significant at 1%
 Table 2. Tracking Error

TE TE TE TE

AnyCFA -0.113 -0.163

(2.44)** (3.69)***
AnyMBA 0.138 0.190
(2.87)*** (4.28)***
CFA -0.125 -0.16
(2.76)*** (2.99)***
MBA 0.079 0.13
(1.61) (2.16)***
KPMexp .004
(1.57)
Growth 0.365 0.39
(5.13)*** (4.41)***
Value -0.030 -0.005
(0.49) (0.06)
Core -0.208 -0.21
(3.29)*** (2.11)***
Ln Size -0.099 -0.08
(7.05)*** (5.57)***
Constant 1.363 1.850 1.388 1.64
(38.55)*** (18.99)*** (40.85)*** (12.61)***
Observations 916 912 916 558
R-squared 0.01 0.18 0.01 0.16
Robust t statistics in parentheses
* significant at 10%; ** significant at 5%; *** significant at 1%
Reference List
Boyson (2002). How are Hedge Fund Manager Characteristics Related to Performance,
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Chevalier, Ellison (1999) "Are some Mutual Fund Managers better than others? Cross-
sectional patterns of behaviour and performance" JF, June 1999.

Golec (1996) (The Effects of Mutual Fund Managers' Characteristics on their Portfolio
Performance, Risk and Fees. Financial Services Review, 5(2), pp. 133-148.).

Gottesman and Morey (2006) "Manager education and mutual fund performance" Journal of
Empirical Finance, 13, pp. 145-182.

Shukla, Singh (1994) "Are CFA charterholders better equity fund managers?" Financial
Analysts Journal, 6, pp.68-74.

Switzer and Huang (2007) "Management characteristics and the performance of small & mid-
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