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On June 16, Morningstar, Inc. released a new study that evaluated how much money mutual fund managers have invested in the funds they manage. Since 2005, the Securities and Exchange Commission (SEC) has required mutual fund companies to disclose how much money fund managers have in the funds they manage.
Accessing manager investment information is not difficult. As a general rule, you can find it in the fund’s “Statement of Additional Information” (SAI), which is usually available either in printed form accompanying a fund’s prospectus or on a fund’s website. If you can’t locate the information in either of these two places, ask the fund’s sponsor to provide it to you.
I would think most investors assume that their mutual fund manager had a sizable amount of his/her own money in the fund(s) they manage. I certainly do; in fact, I have the bulk of my non-cash assets invested in the products I recommend.
Yet the new Morningstar study shows that about half of the mutual fund managers they track have NONE of their own money in the funds they manage. ZERO.
Morningstar found that 47% of US stock funds and 61% of foreign stock funds have no investment of the manager’s own money. Bond funds fare even worse with 66% of taxable bond funds, 71% of balanced funds and 80% of municipal bond funds having no manager investment.
Morningstar’s report offers only a few legitimate excuses for fund managers not to invest in their own funds. These might include “index” funds, “target-date” funds that do not meet the manager’s time horizon, single-state municipal bond funds where the fund manager lives in another state and situations where the manager is a foreign national from a country that bars investment in US funds. Those possible exceptions aside, I find it hard to imagine a mutual fund objective that couldn’t merit at least a small allocation of the fund manager’s own money, many of whom earn millions of dollars per year in management fees.
Perhaps the most interesting part of the study was Morningstar’s analysis of its own “Picks and Pans.” This is a service provided by Morningstar where they select funds that may be good long-term investments (the “Picks”) as well as mutual funds to avoid (the “Pans”). When analyzing management investment in these two groups, Morningstar found that the Picks had a median manager investment of $430,000, whereas the median investment by the fund managers in the Pan category was $0. On average, the Picks had seven times the manager investment than the Pans. Get the message?
While Morningstar is quick to point out that the lack of a manager’s investment does not necessarily doom a fund to poor performance, it certainly doesn’t do anything to help an investor’s confidence in the fund. I think this is especially true in light of recent shenanigans in the financial services industry such as last year’s subprime crisis and the mutual fund scandals just five years ago. Sadly, each of these crises highlighted events where personal self-interest outweighed the duty to put clients’ interests first.
Let me be quick to clarify that I’m not trying to equate managers who don’t invest in their own funds to those responsible for the subprime debacle and mutual fund scandals, but I do think it shows a sense of arrogance on the part of many mutual fund insiders that they expect investors to put money into funds that they won’t even invest in themselves.
The Importance of Personal Investment
Some in the investment world and financial press were shocked at the revelations of the Morningstar study, but not me. After evaluating money managers for over 30 years, it’s hard to be shocked by anything I might uncover. It has not been uncommon for me to come across professional money managers who do not invest in their own programs. Fortunately, I can also attest to the fact that there are many money managers who do put their clients first and do invest alongside them in the funds and programs they manage.
As noted above, I invest my own money in all of the programs my company recommends, which I feel is important. You should also know that I require the money managers that we recommend to “eat their own cooking.” The way I see it, if a money manager’s program isn’t good enough for his/her own money, then it’s certainly not good enough for you or me.
Simply put, if I am going to entrust my clients’ money, and my own money, to an Advisor, I want to know they have a significant percentage of their own money in their programs. If an Advisor doesn’t have his own money in his program, I consider that to be a major red flag.
Interestingly, most of the successful Advisors I have met do have a huge amount of their own money invested in their programs – sometimes even more than they should. When you read over some of the bios of our recommended Advisors, you will find that several of them got into the money management business primarily to manage their own money after retiring from another profession or selling a business.
Upon receiving large payouts, they could not find acceptable money managers for their nest eggs, so they decided to do it themselves. Thus, some of the managers I recommend only started managing money for outside investors after they devised a successful system for managing their own money.
[Via - Gary D. Halbert]
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