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Another Way to Assess a Mutual Fund

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  • 1. 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 database www.sec.gov/edgar.shtml. 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 found. 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.
  • 2. 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.
  • 3. 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 Morningstar study. 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 managers' long-term 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.
  • 4. 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 eleanor.laise@wsj.com