Seek investment managers with skin in the game

Just under half (45%) of U.S. mutual fund managers have their own money in the very products they sell to investors like you. So finds research firm Morningstar Inc.ⁱ We wouldn’t expect the Canadian landscape to look substantially different. That’s a lot of managers with seemingly little confidence in their work, at least not enough to match your financial commitment with their own. Morningstar also discovered that managers holding a minimum of $1 million in the funds they run outperformed the majority of their peers over a five-year timeframe.ⁱⁱ On top of it then, whether your manager invests alongside you is a measurable quality that can prove useful in separating the good performers from the bad apples.

While co-investment alone can’t promise results, it does help to ensure your financial well-being moves in lockstep with your manager’s. When they do something smart, everyone gains. A not-so-smart manoeuver means you both feel the pinch. You each have real dollars on the line to create a clear alignment of interests, and your manager is further incentivized to do the job well and be accountable for it. They have families to feed too. 

In good company

The same idea can be applied to individual companies. As the thinking goes, those that demonstrate high levels of insider ownership tend to be run more prudently and efficiently, which can lead to stronger long-term results. After all, when you invest in a company, you’re really investing in the people behind it and their conduct matters. It’s common sense that employees with a large stake in the success of a business are more motivated to meet – and even exceed – the expectations of their individual role.

Actions > words

Morningstar conducted a similar study two years earlier, in 2008. Since then, personal investment by managers has actually declined by 2%.ⁱⁱⁱ Imagine that during the economic crisis and at the same time investors were being told to stay the course, their managers may have been heading for the hills. You want to entrust your savings to managers who do what they say (and say what they do). Contradictory messages and behaviour won’t help you sleep better a night, and there are enough managers worthy of your money from which to choose.

Exceptions make the rule

Give extra credit to managers who eat their own cooking, but don’t outright shun those who haven’t followed suit. Everyone deserves the benefit of the doubt and there could be good reason for a diminished level of manager assets in a fund. Specialty investments that aren’t diversified or index products where a manager can do little to improve performance are two such examples. Still, if left up to us, we’d look for fund endorsement in the form of a manager’s best seal of approval: their pocketbook.