Are managers who invest in their own funds more reliable?

Published by Cherry Reynard on 16 April 2013.
Last updated on 16 April 2013

Fund manager

A chef who refuses to sample his own food might rouse some suspicions. If it were ancient Rome, the inkling would be that he'd poisoned it, but these days it is more likely to suggest that he isn't prepared to stomach the gloop he is serving to his customers.

And so it is with fund managers. There is a worry that fund managers who hold no investments in their own fund are unwilling to sample their own unappetising concoction.

Some fund management groups hold great store by the fact their managers have meaningful stakes in their own funds, believing it imposes discipline and rigour - Cazenove, Liontrust, Henderson, Threadneedle, Vanguard and Jupiter all set great store by fund managers investing in their own funds alongside investors.

As a rule, it used to be more common in smaller boutique businesses – for example, Mark Slater is the largest investor in all three of the MFM Slater funds – but largely companies are now wising up to its power as both a fund manager incentive and a marketing tool. BlackRock managers such as Sam Vecht (emerging markets) and Evy Hambro (commodities) now hold large stakes in their own funds, for example.

Liontrust chief executive John Ions believes fund managers investing in their own funds is a clear incentive to perform well: "If we are asking other people to invest in our funds, why wouldn't we invest ourselves? All our managers have significant investments in their own funds, and they don't use anything other than our funds for their savings."

Although no absolute limit is proscribed at the corporate level, Ions reasons that as their managers have devised their investment approach themselves, they should believe it adds value and therefore want to invest. He says it is also about ensuring focus. A manager who spends the first hour of his morning trading his personal portfolio of stocks only has half an eye on the job of running his fund.

While this is a strong argument, it also makes a virtue of necessity. To avoid conflict of interest rules, fund managers usually have to declare any external investments. This can be a complex and intrusive process. It is often far easier to invest in the internal fund.

There certainly appears to be an increasing emphasis on investing alongside unitholders. A 2011 survey of fund managers by Citi and Create Research found only 8% put their bonuses into the funds they managed in 2010. This was expected to increase to 13% in 2011.

Andrew Wilson, head of investment at Towry Law, says the real picture is better than this would suggest: "We have found that it is becoming standard practice." He sees this as a good thing, adding: "It is a prerequisite for us that a manager invests in their own funds unless there are truly exceptional circumstances, because we believe that it creates an alignment of interests."

A PricewaterhouseCoopers survey recently found that fund management groups were increasingly trying to link the remuneration of their managers more closely to performance by tying pay to fund, or desk, performance rather than a company's overall profitability:

"Firms were doing this in order to link investment professionals' reward more directly to their performance, so that they did not receive low rewards in years when they had performed well but the overall corporate bonus pool might be low."

This is admittedly not quite the same as ensuring managers invest in their own funds, but it does ensure that managers have 'skin in the game' – they win if their investors win and lose if their investors lose.

That said, there are still plenty of managers not prepared to sample their own 'gloop'. In the US, it has been obligatory for fund groups to disclose how much their managers invest in their own funds since 2006 and this has prompted a significant expansion in the practice.

There is no research to suggest that this has improved or detracted from overall fund performance, but intuitively, it seems like progress.

Compelling arguments

So, should the UK embrace compulsion? There are some potentially negative implications to compulsion – not least because it assumes the interests of shareholders and fund managers are always aligned, which they may not be. This has perhaps been most apparent in the hedge fund world.

Hedge fund managers have generally been willing to take significant risks because they are wealthy and can afford to do so. This may not be what their clients have been looking for from the fund. Equally, the opposite might be true for fund managers nearing retirement.

John Chatfeild-Roberts, head of the Jupiter Merlin multi-manager team, sounds a note of caution: "It used to be that we would always want managers scam found that some managers had to invest in their own funds. Then we so much invested in their own funds, they lost their appetite to take risk. If the fund is the largest proportion of their wealth, they become that bit more scared.

As a result, we put a little less emphasis on it these days." He says investors should really seek to understand whether a manager is properly incentivised and happy. If they are, they are likely to stay in their job and continue to manage money effectively. If they are not, investors have a problem. He says: "It is all about fairness and empowerment. We want to see that an organisation manages to be fair to all the people within it."

The downside

Robert Burdett, joint head of multi-manager at Thames River Capital, also sees some problems with a blanket insistence that managers invest in their own funds: "Some managers will argue that they don't have anything in their own funds because their entire life is geared into the performance of the stockmarket. If the stockmarket falls, their whole livelihood is at risk, so they want to diversify with their personal wealth and I have some sympathy with that argument."

He gives the example of one group where fund managers were all forced to reinvest their bonuses back into their funds. This is fine if it is a 30-year- old manager running a technology fund. It is not so helpful if it is a 60-year-old managing a technology fund.

He has also seen incidences when managers have been 'over-motivated' and have taken too much short-term risk. He argues for a more nuanced approach, saying that while he likes to see managers investing in their own funds, he understands that there may be times when it is not appropriate.

Ions says Liontrust has checks in place to ensure that managers do not stray from their investment style to suit their own investment goals. Investment research companies such as Style Research provide tools whereby fund managers can check whether there is any 'creep' away from a fund's strategy.

Ions says Liontrust would take immediate steps to address any discrepancy, but investors need to check that other managers have similar rigour.

But if investors accept that, with some exceptions, it is generally desirable for a fund manager's interests to be linked with those of their investors through investment in the fund, they face another hurdle. For private investors, it is relatively difficult to get hold of information on a fund manager's holdings in their own funds.

It is not usually published unless the fund manager sees it as a key part of their marketing strategy. It is much easier with investment trusts, where it is possible to see not only holdings by fund managers, but also by board directors as well. For private investors in open-ended funds, the only real way to find out is to ask the management company.

Wilson says fund managers are usually willing to provide the information: "You won't find it on the factsheet but most are happy to talk about it." According to Burdett, there is a reluctance to commit the information to paper: "We found it was a waste of time asking for it in our written questionnaires but in a face-to-face meeting you can take the questioning where you need to go."

A fund manager investing in their own funds is undoubtedly an endorsement. However, there can be drawbacks. Equally, if a fund manager is not willing to invest his own fund, an investor needs to do their homework to understand whether it is because the fund is 'unappetising gloop' he doesn't fancy eating, or whether he just needs the money for a new car.

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