What a Difference a (Birth) Month Makes: The Relative Age Effect and Fund Manager Performance

Kevin Mullally is Assistant Professor of Economics, Finance, and Legal Studies at the University of Alabama Culverhouse College of Commerce. This post is based on a recent article, forthcoming in the Journal of Financial Economics, authored by Professor Mullally; Jianqiu Bai, Assistant Professor of Finance at Northeastern University D’Amore-McKim School of Business; Linlin Ma, Assistant Professor of Finance at Northeastern University D’Amore-McKim School of Business; and David Solomon, Assistant Professor of Finance at Boston College Carroll School of Management.

The academic literature in finance has focused a lot of attention on how managerial characteristics impact firm performance. One such characteristic that has received considerable study is overconfidence. This is generally thought of as managers being overly optimistic about their own ability or their firm’s prospects. Although there is evidence that managerial overconfidence can benefit firms via higher innovation, a majority of papers find that overconfidence negatively impacts firm value. A curious aspect of this literature is that the primary object of study is “overconfidence,” rather than just “confidence.” Papers such Malmendier and Tate (2005) find that greater confidence is associated with greater mistakes. Interestingly, this notion that confidence is associated with worse performance contrasts with a large literature in psychology that finds a positive relation between confidence and performance.

In our paper, What a Difference a (Birth) Month Makes: The Relative Age Effect and Fund Manager Performance, we examine how one early childhood experience impacts mutual fund managers’ confidence and their funds’ performance. Most education systems in the United States have a single cutoff date for school eligibility. This means that children who were born immediately after the cutoff date are almost 12 months older when they enter kindergarten than those children who were born just before. Given an initial 20% age difference and the associated gaps in maturity, it is unsurprising that the oldest children in their kindergarten class outperform their younger peers academically and athletically at a young age. It is more surprising that this gap in performance persists throughout adolescence as the relative age difference becomes smaller. For example, relatively younger students are less likely to attend college and also earn lower wages. This performance gap has been termed the “relative age effect.” It has been suggested that the long-term effects are driven by a higher level of confidence that arises from early life successes, as well as relatively older students receiving better education and training because they are viewed as more talented at a young age.

Our main finding is that funds run by managers in the top quartile of relative age outperform those run by managers in the lowest quartile of relative age by 0.477% per year in terms of abnormal performance. The stocks chosen by the relatively oldest managers outperform those chosen by the relatively youngest managers by 1.62–1.76% per year. We utilize information from LexisNexis Public Records database to obtain data an individual’s birth month and year, as well as the state of issuance, from which we can calculate the relative age of our sample of mutual fund managers.

We argue that relative age acts as an exogenous driver of managerial confidence. It is determined at a point in time long before most other environmental influences, it has a relatively small number of potential channels through which it can operate, and it is difficult to relate to most standard determinants of fund performance. To provide direct evidence supporting the role of confidence in relative age, we first examine whether relatively older managers are perceived as appearing more confident. We downloaded the LinkedIn profile pictures of a random sample of the relatively oldest and relatively youngest managers in our sample and asked Amazon Mechanical Turk survey respondents who they perceived as being more confident. The survey respondents were given absolutely no information about the identities of these managers. Despite the fact they were comparing small, posed, and often poor quality pictures, the survey respondents identified the relatively older managers as appearing more confident 55% of the time. The likelihood that this outcome occurred by chance is 0.0023%. Using the same sample of managers and the same set of random pairings, survey respondents did not detect meaningful differences in trustworthiness or attractiveness. Potential investors, colleagues, and employees likely have a much richer set of body language and behavior to evaluate which suggests that the differences we measure understate the true difference in the perception of these managers.

In addition to appearing confident, relatively older managers also act in ways consistent with greater confidence. Specifically, we found evidence that these managers were more likely to buy stocks that deviated from their funds’ stated benchmarks. Our results also indicated that these managers displayed more aggressive trading behavior by holding larger positions of fewer stocks. We also found that they were engaged in less window dressing behavior (e.g., they were more willing to disclose their true portfolios). Lastly, the relatively older managers were also able to attract higher capital flows to their funds even after controlling for any differences in performance. This result suggests that these managers’ confidence may also help them market and promote the funds they manage.

Our findings point to a novel conclusion: in contrast to the literature on overconfidence, we find that higher manager confidence leads to better performance. The results from our paper suggest that it is also possible to be underconfident and that, in certain settings, this could lead to adverse effects for performance. Broadly, our paper suggests that it is not confidence per se, but confidence relative to what one actually knows that has an impact on performance.

The complete paper is available for download here.

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