Labor Mobility and Productivity: Evidence from Finance

We use unique data on careers of investment managers to study the relation between labor markets and productivity differences across sectors in finance. We document significant labor mobility between mutual funds and hedge funds during the 1990s and 2000s. Descriptive evidence suggests potential inefficiencies in the allocation of skill and capital: switching from mutual funds to hedge funds results in large gains in return-based productivity and value-added. Hedge funds absorb mutual fund managers from the left and the right tails of the distribution of abnormal returns, lower Sharpe ratios, and higher volatility. To explain these patterns, we estimate a simple model of supply and demand for labor, with heterogeneous sector-specific skills. The model is identified using shocks to investor demand. Selection of low-skilled mutual managers into hedge funds was driven by a decrease in the mutual fund demand for such managers, an increase in hedge fund demand across the skill distribution, and idiosyncratic expected gains. Selection-adjusted average treatment effects show a much smaller hedge fund premium in return-based productivity and a we cannot reject a zero premium in value added.