Peixin Huang MSc Accounting and Finance
In this study, I investigate how the social connections between the mutual fund managers and portfolio firms’ (investees’) senior executives affect the funds’ investment decisions, holdings’ return, and monitoring duties in China.

Mutual fund is an open-end investment vehicle that holds a pool of assets and issues shares to the investors. Mutual fund managers are appointed by the fund management companies to manage the fund's assets and make investment decisions based on their professional discretions. To outperform other funds, fund managers might either need to have the superior stock-picking ability or obtain information advantages over other funds.

Finance scholars such as Golec[1], Chevalier and Ellison[2], and Gottesman and Morey[3] find that education matters in explaining the funds’ return. However, these studies cannot distinguish whether the outperformance is a result of the superior stock-picking ability derived from the talent effect, or the information advantages within the alumnus network. Later studies suggest that the common educational backgrounds between the fund managers and investees’ executives facilitate information exchange, and lead to outperformance.[4] The sociology literature also argues that social connections facilitate information transmission.[5] Hence, the information advantage explanation seems plausible to justify why fund managers with higher degrees outperform others as they are more likely to attain the information advantages when they are socially connected with other alumnus.

However, the detrimental side of social networks is potential collusion within the network.[6] Gu et al.[7] and Gao et al.[8] find that the fund managers might collude with the sell-side analyst and investees’ executives, at the expense of fund investors. Hence, the agency problem might arise as the agents’ (the fund managers’) interests are misaligned with the owners (investors) by favouring those who are socially connected, such as connected investees. To the extent that fund managers are incentivised to favour or collude with the connected investees, this study hypothesises that the fund managers might overinvest the connected investees. In addition, this study predicts that these connected holdings might not generate a better return to the funds, and the funds' managers might not exert the effort in monitoring the connected investees’ governance when they are colluding.

This study is conducted in the Chinese mutual fund market, the largest emerging market in the world. There are serval reasons to study the Chinese market. Firstly, the Chinese fund market has started to grow explosively since the start of the 21st century. During 2000, the CSRC started to encourage the development of open-end funds as institutional investors to invest in the tradable 'A' shares to stabilise the Chinese stock markets.[9] The number of mutual funds has increased from 5 in 1998 to 6,544 in 2019. The funds’ net asset value has increased from 10.74 billion yuan in 1998 to 14.77 trillion yuan in 2019, which account for 14.91% of China’s GDP and 30.55% of the equity market capitalisation in 2019 (See China Securities Investment Fund Fact Book, AMAC, 2019/2020).

Despite the explosive growth in the Chinese fund market in recent decades, the return of the funds seems to be not improving much, where Gao et al.[10] argue that the fund returns are lower than the management fees charged. Secondly, different from the developed market where the firms’ information is sufficiently disclosed, the Chinese market tends to have a scarcer public disclosure, which makes the fund managers resort to private sources of information.[11] Lastly, commercial activities in China are well-known to be dominated by social connections.[12] Owing to these facts, it motivates this study with an important research question and serval testable hypotheses to examine how social connections play a role in the context of mutual fund operations, which might be different from what others have documented for more mature markets (such as the US market).

This study uses the school ties between the fund managers and investees’ executives to proxy the social connections, because social connections are more likely to emerge when people share common educational backgrounds.[13] Following Cohen et al.[14], this study defines three types of social connections, depending on whether the fund managers graduated from the same university as the investees’ executives (Connect1), whether they received the same degree from the same school (Connect2), and whether they share both geographical ties and school ties (Connect3). This study regards Connect1 as the weakest form of connection and Connect3 as the strongest form. To measure the connection variables, a uniquely hand-collected dataset has been developed to identify the connections between 1,014 funds and 4,034 investees.


In this study, I examine how the social connections between the fund managers and investees’ executives impact their funds’ investment decisions, holdings return, and monitoring roles in China. Using hand-collected data for the fund managers’ education information, I measure the social connections by matching the education information of fund managers with the investees’ executives and define three types of connection, from the weakest to the strongest. Using these three connection measurements, I show that fund managers tend to overinvest the connected investees, and the external monitoring by the financial institutions mitigates this tendency only if the funds do not share strong connections with the investees’ executives (Connect1). Further, I show that there is no information advantage within the network since the connected holdings tend to perform worse than the unconnected holdings. Lastly, I fill the research gap by investigating whether the fund managers would exert less effort in governing the investees if they share connections.

The findings show that the monitoring role of the fund manager tends to be weakened when they share connections with the investees as evidenced by the poor investees’ accounting performance and higher pay to the connected investees’ executives. The overall results suggest that social connections would lead to agency conflict between the fund managers and investors, where the evidence is in favour of the detrimental side of the network (Collusion) rather than information advantages. Finally, this study also confirms that the findings are not subjected to the endogeneity issues (namely, omitted variables).

The findings have two implications for the fund investors and policymakers. First, fund investors should not invest in the funds that hold large proportions in firms whose executives share school ties with the fund managers, since evidence suggests that the fund managers might breach their fiduciary duty in favouring the connected investees. Secondly, to ensure that the fund industry sustainably develops, the CSRC must improve investor protection and impose stricter regulations to monitor the funds’ operations. Potentially, the CSRC could require the fund managers to justify the reason for each trade and disclose their connections with the investees’ executives privately when the investment weight reaches a certain threshold.


[1] Golec, J., (1996). The effects of mutual fund managers' characteristics on their portfolio performance, risk and fees. Financial Services Review, 5(2), pp.133-147.

[2] Chevalier, J. and Ellison, G. (1999). Are some mutual fund managers better than others? Cross-sectional patterns in behavior and performance'. The Journal of Finance, 54(3), pp.875–899.

[3] Gottesman, A. and Morey, M., (2006). Manager education and mutual fund performance. Journal of Empirical Finance, 13(2), pp.145-182.

[4] Cohen, L., Frazzini, A. and Malloy, C. (2008). 'The small world of investing: Board connections and mutual fund returns'. Journal of Political Economy, 116(5), pp.951–979.

[5] Useem, M. (1986). The inner circle: Large corporations and the rise of business political activity in the US and UK. New York: Oxford University Press.

[6] Granovetter, M. (1985). 'Economic action and social structure: The problem of embeddedness'. American Journal of Sociology, 91(3), pp.481–510.

[7] Gu, Z., Li, Z., Yang, Y.G. and Li, G. (2019). 'Friends in need Are friends indeed: An analysis of social ties between financial analysts and mutual fund managers'. The Accounting Review, 94(1), pp.153–181.

[8] Gao, X., Wong, T.J., Xia, L. and Yu, G. (2020). 'Network-induced agency conflicts in delegated portfolio management'. The Accounting Review, 96(1), pp.171–198.

[9] Firth, M., Lin, C. and Zou, H. (2010). 'Friend or foe? The role of state and mutual fund ownership in the split share structure reform in China'. Journal of Financial and Quantitative Analysis, 45(3), pp.685–706.

[10] Gao et al. (2020).

[11] Gold, T., Guthrie, D. and Wank, D.L. (2002). Social networks in China : institutions, culture, and the changing nature of Guanxi. Cambridge, UK: Cambridge University Press.

[12] Xin, K.K. and Pearce, J.L. (1996). 'Guanxi: Connections as substitutes for formal institutional support'. Academy of Management Journal, 39(6), pp.1641–1658.

[13] McPherson, M., Smith-Lovin, L. and Cook, J.M. (2001). 'Birds of a feather: Homophily in social networks'. Annual Review of Sociology, 27(1), pp.415–444.
Louch, H. (2000). 'Personal network integration: transitivity and homophily in strong-tie relations'. Social Networks, 22(1), pp.45–64.

[14] Cohen et al. (2008)

10 November 2022