Are specialists and generalists interchangeable in asset management?

As of 2021, nearly half of U.S. households about 108 million individual investors — owned a mutual fund, and that share is only expected to grow in the future. The U.S. mutual fund industry is worth a staggering $27 trillion. “When we look at the implications, it is not just about professional wealth investors, it’s also about the retail or nonprofessional investors. The research that we do in this area has a broader implication for the entire society,” said Rafael Zambrana, an assistant professor of finance at the University of Notre Dame’s Mendoza College of Business. “It's important that we understand the consequence of every decision that asset management companies make in this industry.”

Zambrana became interested in asset management while working for a firm and handling several hedge funds after earning his undergraduate degree. Since entering academia, he has become an expert in the investment behavior of institutional investors and the impact of their trades on stock markets as well as on portfolio manager incentives and the role of political identity and business connections in the asset management industry. Zambrana’s latest research in the area of asset management was compiled in the paper, “A tale of two types: Generalists vs. specialists in asset management,” published in the Journal of Financial Economics by co-authors Zambrana and Fernando Zapatero of the Questrom School of Business at Boston University. The authors were particularly interested in studying the allocation of specialized human capital in the asset management industry. Within the context of asset management, specialists are money managers who run securities within a narrow mandate, and generalists are money managers who run securities that simultaneously meet different investment objectives. Previous research has indicated that specialization could have a positive effect for venture capital firms, but specialization’s role is still considered unproven. “For example, we see that the specialized CEO earns less money than the generalist CEO,” said Zambrana. From a sample of 1,456 open-ended U.S. equity mutual funds from the Center for Research in Securities Prices (CRSP) Mutual Fund database, the researchers observed that roughly 70% of the total assets in their sample were managed by generalist managers. This propelled them to ask why such a distinct allocation between specialists and generalists should exist and what were the consequences of such an allocation. To begin, they defined two different market strategies among fund managers: stock picking and market timing. In the case of stock picking, the fund manager relies on detailed information at the microeconomic level. They seek to identify undervalued stocks by reading financial statements and researching management composition and the consumer base. Alternatively, market timers rely on information at the aggregate, macroeconomic level. Rather than being specific to any sector or company, they use a wide range of data to forecast market trends, GDP growth, interest rates and term structures. In practice, whether a money manager is a specialist or generalist has no bearing on whether they perform as a stock picker or market timer. This became the crux of the study. “That prompted us to question what are the determinants?” said Zambrana. “Can we observe this type of allocation in how fund families deploy personnel? And if not, what are the reasons?” After observing the data, the researchers concluded that there clearly exists an optimal allocation of human capital in asset management. When a management company appoints a stock picker to a specialist assignment and a market timer to a generalist assignment, the company earns about 2% higher returns per year than the market on a risk-adjusted basis. “When you take this at the aggregate level, given that there are trillions of dollars in this industry, 2% makes a huge difference,” said Zambrana. “Some say the fact that managers are allocated into a specialist role, or a generalist role, will not make a difference because these are very professional people, they are experts. We showed that no, it actually does matter.” Given the financial implications, Zambrana was surprised that more management companies are not allocating their pickers and timers accordingly. However, the study also revealed that there are constraints for smaller management companies that do not have the resources or talent pool to deploy their personnel in an optimal way. “We realized that this was not up to them, whether they had this optimal allocation, that was actually the market causing the constraint,” he said. “Because the management companies were still very small and specialized in a single product, they didn't have enough money to assign a generalist position.” Zambrana likes to use this study in his corporate finance courses to help shift his students’ thinking from assuming that being a generalist is always better than being a specialist. He also believes more research can be done into how these roles might shape the ideal career path for portfolio managers. “What if specialists and generalists are at different levels?” he asked. “Perhaps, when portfolio managers start, they are specialists so they learn about specific things. And then with time, with more tenure, they become generalists. They manage different portfolios, and also the compensation increases, so becoming a generalist is more like a promotion.”