After more than two decades of managing mutual funds, we have found that there is no single factor that determines successful performance in a fund. Much like a chef preparing a gourmet dish, the recipe for long-term performance in a mutual fund requires a multitude of ingredients. Rigorous in-depth research, thoughtful portfolio construction, and strong buy/sell disciplines are a few critical ingredients. However, one element that is often overlooked is how the investment team is incentivized. Do managers own their own funds? Is the investment team rewarded for short or long term performance? Research shows the answers to these questions can be an indicator of sustainability and performance.
“Morningstar… found 47% of U.S. stock fund managers had not invested a dime in the funds they managed.”
The Proof is in the Pudding
Morningstar has studied the topic of portfolio manager ownership for more than a decade and has reported several data points that reinforce the notion that manager ownership is important. Research published by Morningstar in 2014 found 45% of U.S. stock fund managers had not invested a dime in the funds they managed.1 What is not surprising is the same study demonstrated a positive correlation between a fund's performance and managers who co-invest with shareholders. Such studies were based on SEC filings that require mutual fund managers to disclose personal investments in the funds they manage.
While investing with a manager that has “skin in the game” is not a sure fire ticket to above average performance, it does align the manager's interest with that of the shareholders. When selecting public companies for our portfolios, we always consider how much insider ownership exists among the top officers and directors of a company. This is based on the fundamental idea that owners act like owners and not just employees. After twenty six years of analyzing thousands of publicly traded companies, we have found a high correlation between solid corporate governance and insider-ownership. We think this same principle applies to the ownership of portfolio managers in the funds that they manage.
1Average Overall Star Rating Source: Morningstar
Average Overall Star Rating - Core Stock Funds
As of 04.27.2014
We would highlight that some of the most successful and
Risks Associated With Portfolio Manager Ownership
There are risks associated with a manager owning their own funds as well. If a fund manager’s personal account is largely overweight with the fund they manage, that manager, consciously or subconsciously, may manage the portfolio to his or her risk tolerance instead of that of the mandate of the fund. This may present a long-term style drift for a fund with a tenured manager or render past performance irrelevant.
At Hodges Capital, we believe that the potential rewards with being invested in our own funds
Food For Thought
Just as you would not hire a vegetarian as the head chef at a renowned steakhouse, we believe it is important for investors to consider a manager's personal ownership when selecting a mutual fund. At Hodges Capital Management, we “eat our own cooking” as all of our portfolio managers have meaningful ownership in the mutual fund(s) that they manage.
Mutual fund investing involves risk. Principal loss is possible. The Funds may invest in small- and medium-capitalization companies, which involve additional risks such as limited liquidity and greater volatility. Investment in foreign securities and emerging markets involve greater volatility and political, economic, and currency risks and differences in accounting methods. The use of options and future contracts have special risks such as unlimited losses and the underlying holdings due to unanticipated market movements and failure to correctly predict the direction of securities prices, interest rates, and currency exchange rates. Funds that make short sales of securities involve the risk that losses may exceed the original amount invested. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. Funds that are non-diversified are more exposed to individual stock volatility than a diversified fund. Investments in companies that demonstrate special situations or turnarounds, meaning companies that have experienced significant business problems but are believed to have favorable prospects for recovery, involve greater risk.
Past performance is no guarantee of future results.
Positive Correlation: A relationship between two variables in which both variables move in tandem. A positive correlation exists when as one variable decreases, the other variable also decreases and vice versa.
The Securities and Exchange Commission (SEC) does not approve, endorse, nor indemnify any security.
Investment performance reflects fee waivers in effect. In the absence of such waivers, total return would be reduced.
© 2017 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.
Opinions expressed are those of the author or Funds and are subject to change, are not intended to be a forecast of future events, a guarantee of future results, nor investment advice.