If a mutual fund manager won't invest in a fund that he or she is managing, why should anyone else?
If a mutual fund manager won't invest in a fund that he or she is managing, why should anyone else? It isn't a rhetorical question.
According to Morningstar Inc., only about 40% of fund managers invest in their own funds. Of that minority group that is “eating its own cooking,” about 60% are equity managers.
“It's a little baffling to me why we see so many portfolio managers with zero money invested in their own funds,” said Laura Lutton, editorial director at Morningstar.
On the fixed-income side, where investment by managers tends to be lower than in equity funds, there is some justifiable leeway given to managers who run certain short-term-bond strategies or -single-state municipal-bond funds.
But overall, it is difficult to understand why a portfolio manager can't invest even $1,000 in his or her fund, if only to replace the zero investment figure on public filings.
Beginning in 2005, the Securities and Exchange Commission required fund manager investment status to be filed under a statement of additional information.
Beyond the symbolic benefits of showing investors that a manager has some skin in the game, there are real and measurable advantages to having the portfolio manager in the investor pool.
According to Morningstar's continuing stewardship research on funds and fund companies, on average, the more money a portfolio manager invests in a fund, the better the fund does.
Of the funds at the highest manager investment level of more than $1 million, the average star rating is 3.5 and the average manager tenure is more than 12 years.
On the opposite end of the spectrum, including funds where the manager has no money invested, the average star rating is 2.9 and the average tenure is 4.6 years.
Morningstar includes portfolio manager investment data in its overall stewardship analysis, which will be part of the forward-looking analyst fund ratings that will make their debut this year.
Of course, not everyone gives the same value to portfolio manager investment.
“I don't have an answer as to why a manager wouldn't invest in his own fund, but we don't think it's a major red flag,” said Todd Rosenbluth, mutual fund analyst at Standard & Poor's Financial Services LLC. “It's something investors should care about, but I don't think they should exclude a fund because the manager doesn't invest in it.”
One reason that Mr. Rosenbluth has heard as to why a manager doesn't invest is related to the risk of personal bias.
“As a manager, you might be less likely to take profits if you're also an investor,” he said.
Most fund companies don't have formal policies regarding manager investment in funds they manage, but some firms clearly make it a priority.
Ms. Lutton cited Royce & Associates LLC, a $40 billion small-cap-value firm, as “a very good example.”
Lead managers at Royce are required to invest at least $1 million of their own money. For co-managers, the minimum requirement is $500,000, and for assistant managers, $250,000.
In addition to a salary, Royce manager compensation also is based partially on fund performance.
“We think it's important that our managers align their interests with those of the shareholders,” said Jack Fockler, Royce's managing director.
VANGUARD GROUP
In terms of fund companies where manager investment isn't a priority, Ms. Lutton highlighted The Vanguard Group Inc., a $1.4 trillion fund complex. Of the 114 distinct Vanguard funds tracked by Morningstar, 81 have zero investment from the portfolio manager.
Vanguard spokesman John Woerth described the analysis of portfolio manager investment as “sort of misleading” and “an imprecise mechanism for evaluating a fund.”
Vanguard does have manager incentive and penalty compensation structures on most of its funds as a way to align manager interests with those of the fund investors, he said.
In some cases, managers will opt to invest in a separate-account version of the fund, which doesn't show up in the SEC filing, Mr. Woerth said.
However, while the separate account might put the manager and the fund investor in the same general universe, Ms. Lutton noted that separate-account investors aren't subjected to the same taxable events or fee structures as mutual fund investors.
Donald Butler, who is listed as lead manager on four Vanguard funds that combine for nearly $150 billion, is invested in only one of those funds.
According to Morningstar, he has between $10,000 and $50,000 invested in the $1.8 billion Vanguard Tax-Managed International Fund Ticker:(VTMGX).
Mr. Butler said that he “invests 100% in Vanguard funds” and that he is mostly invested in the Vanguard total-stock and total-international funds. He does not duplicate holdings in different funds.
In addition, one of the funds that Mr. Butler manages, Vanguard Institutional Index Fund Ticker:(VINIX), has a $5 million initial-investment requirement, and Vanguard doesn't waive minimums for employees. If he were to invest in that fund, it would lead to a lot of exposure for him to the one fund.
There will always be reasons for managers not to invest in funds that they manage, but it is tough to dodge the stigma of not owning a fund you are managing.
As Morningstar's president of fund research, Don Phillips likes to say: “Nobody ever washes a rental car.”
Questions, observations, stock tips? E-mail Jeff Benjamin at jbenjamin@investmentnews.com.
