NCPA - National Center for Policy Analysis


September 8, 2008

It's not what you know; it's who you know in the investment world, say researchers from the National Bureau of Economic Research (NBER).  University connections are not only common, they are profitable.  Holdings of such "connected" companies outperform "non-connected" stocks by up to 8.4 percent a year.

It's true that managers tend to place bigger bets on companies with board members who share the same college or university affiliation, but the NBER study further suggests that these links give fund mangers an informational advantage over other investors.

To test their hypotheses, researchers focused on 2,501 portfolio managers of 1,648 actively managed equity funds between January 1990 and December 2006.  They then matched the managers' education backgrounds with those of 42,269 board members and 14,122 senior officials at 7,660 traded companies finding many ties.  For example:

  • Of all publicly traded firms in the United States, 12 percent have mid-level managers and/or senior officials with Harvard degrees; so do portfolio mangers at 16 percent of active equity mutual funds.
  • Among managers with the strongest connection to senior officials (same school at the same time with the same degree), the connected holdings earned an average annual 16.05 percent excess return; that is more than double the fund's average 7.69 percent excess return on non-connected stocks or the fund's overall average: 7.81 percent.
  • Moreover, researchers found a significant advantage in performance - up to 6.32 percent per year for the strongest connection - for connected stocks that mangers owned compared with connected stocks they chose not to own.

The researchers tested alternative explanations, but in no case could they find a factor other than educational connection to explain either the managers' large bets on connected stocks or the significant abnormal returns they earned.  Social networks, they concluded, are important for information flow between firms and investors.

Source: Lauren Cohen, Andrea Frazzini and Christopher Malloy, "The Small World of Investing: Board Connections and Mutual Fund Returns," National Bureau of Economic Research, Working Paper, No. 13121, May 2007.

For text:


Browse more articles on Economic Issues