Another Way to Assess a Mutual Fund
Evidence Mounts That Performance Improves
When Managers Invest in Their Own Portfolios
By ELEANOR LAISE
WSJ July 26, 2006; Page D1
As mutual-fund companies push managers to invest in their own funds, investors are
gaining a new angle on deciding where to put their money.
Funds whose managers have a personal financial stake tend to reward individual
investors with superior performance over funds that don't have such close manager
involvement, a new study shows. Investors can check up on their fund managers'
holdings now that the Securities and Exchange Commission has required funds since last
year to disclose that information. Still, fewer than half of U.S. mutual funds included
investments by managers, the study found.
Many fund companies have begun to require managers to tie their personal fortunes to
their funds. Franklin Resources Inc.'s Franklin Templeton Investments and Janus Capital
Group Inc. have started directing a portion of managers' bonuses or incentive pay to the
purchase of shares in their funds. Previously, these awards were made mainly in cash or
company stock. At Legg Mason Inc.'s Royce & Associates funds, senior portfolio
managers must accumulate an investment of at least $1 million in each fund they manage,
and assistant managers must invest at least $500,000.
Some companies, including Putnam Investments, have begun making managers'
ownership information more readily available in a fund's prospectus or on their Web
sites. Investors typically must look for these data in a fund's statement of additional
information, which often must be requested from the company or retrieved at SEC
The moves to encourage manager ownership could benefit investors. Researchers at the
Georgia Institute of Technology and London Business School found that funds with
managers who owned some fund shares at the end of 2004 delivered an average return of
8.7% in the following year. This exceeded the 6.2% average return by funds without
manager ownership for the same period.
The study, which examined about 1,300 U.S. mutual funds, showed that manager
ownership was highest in domestic stock funds and lowest in international bond funds.
For every 0.01% increase in manager ownership, fund performance improved 0.03%, it
Fund managers "will mind the shop a lot better if their own assets are mixed in as well,"
says Tom Carstens, a partner at wealth advisory firm Lenox Advisors.
While manager ownership
data can be useful in helping
to select a fund, the
information can be difficult
to assess, and investors must
weigh a host of other factors
such as expenses and
strategy, financial advisers
say. For one thing,
managers' holdings aren't
listed in exact dollar
amounts, but rather in
ranges -- $1 to $10,000, for instance, or $100,001 to $500,000 -- giving an imprecise
picture of how much is invested. Also, investments aren't disclosed as a percentage of a
manager's net worth, so investors can't get a perfect understanding of his financial
commitment to the fund. Even a $50,000 or $100,000 investment may be just a token
commitment for many portfolio managers, advisers say. The median compensation for
mutual-fund managers in 2005 was $390,000, according to a survey by Russell Reynolds
Associates and the CFA Institute.
Investment research firm Morningstar Inc. takes managers' holdings into account when
awarding "stewardship grades," which are intended to measure a fund's friendliness to
shareholders. Other factors Morningstar considers in those ratings include expense ratios
and degree of board independence.
Morningstar recently ranked fund families by the level of manager investment and found
wide disparities. Janus topped the list with an average manager investment of nearly $1
million. Some of the firm's fund managers with more than $1 million invested include
Jonathan Coleman, with Janus Enterprise fund, David Decker, who runs Janus Contrarian
fund, and James Goff, of Janus Research fund, according to the latest company filings.
Other fund families that earned high marks in the Morningstar survey were Royce &
Associates, with an average manager investment of $877,000; Artisan Partners, with
$712,000; and Capital Research & Management Co.'s American Funds, with $597,000.
Near the bottom of the Morningstar rankings were Bridgeway Capital Management, with
average manager investment of $69,000; Morgan Stanley, with $66,000; and TIAA-
CREF, with $10,000.
TIAA-CREF says its managers have greater sums committed to their investment
strategies than the mutual-fund data indicate. That's because the same investment
strategies the firm uses in its mutual funds are also used in other financial vehicles,
including retirement-plan variable annuities, it says.
At Bridgeway, John
Montgomery, the firm's
founder and lead portfolio
manager for most of its
funds, says that, excluding
his stake in the firm, about
80% of his net worth is
invested in Bridgeway
funds. A Morgan Stanley
spokeswoman declined to
comment on the
Other companies pushing
fund managers to invest
more include Sentinel Asset
Management Inc., which
requires that half of deferred
compensation payouts be
invested in a manager's own
fund. And Janus, besides
directing a portion of
incentive compensation into
fund shares, has introduced
guidelines saying that managers should have invested an amount equal to at least twice
their annual base salary in funds they manage.
Brazos Capital Management recently began tracking managers' investments in their funds
and aims to have each manager invest at least 33% of his net worth in the funds. Bank of
America Corp.'s Columbia Management unit says it expects to introduce a plan that will
encourage managers to invest in their funds by the end of the year. And Wachovia Corp.'s
Evergreen Investments requires managers to invest either $1,000 or $10,000 in each fund
they manage, depending on their job title.
Ajay Khorana, associate finance professor at the Georgia Institute of Technology and co-
author of the study of management ownership, says managers personally invested in a
fund may have greater incentive to maximize returns through such practices as keeping
trading costs down. Also, because a manager can have a good sense of how well his fund
is going to perform, he will invest when the outlook is favorable, Mr. Khorana suggests.
Whatever the reason why manager ownership goes along with better fund performance,
it's "good news for the shareholder," he says.
Managers at some of the largest fund companies, including Vanguard Group, Fidelity
Investments and T. Rowe Price Group, aren't required to invest in their own funds,
though many do so voluntarily, the companies say.
In some cases, it's not appropriate for a manager to hold a substantial stake in his own
fund, as when a relatively young person manages a conservative bond fund, says a T.
Rowe Price spokesman.
"We have fund managers allocate their investments based on their own personal
investment needs and goals," a Vanguard spokeswoman says. Average manager
investment at Fidelity and T. Rowe Price topped $400,000, according to the Morningstar
survey, while Vanguard's average manager investment was just below that mark.
Write to Eleanor Laise at email@example.com