Funds: Follow the directors with 'skin in the game'

If the managers won't invest in their funds,why should you, asks David C Stevenson.

Director share dealings are often seen as a useful signal as to whether or not to buy a company's shares if the directors don't have the conviction to own their own company, then why should you? The same goes for investment trusts, but with an extra dimension we need to look at what amount of a trust's shares have been accumulated over time, by both directors and managers. We can then better understand just how closely aligned the fund is with our long-term objectives ie, are we accumulating wealth alongside the fund managers?

I've just read a gem of a paper Skin in the Game from Alan Brierley, head of investment trust research at Canaccord Genuity, which looks at exactly this point. Brierley has mapped out the interests of fund managers and directors in precise detail. He is careful not to make any bold assertions, such as "only buy funds where the insiders have big interests". Obviously, the mere fact that a director or manager owns gazillions of shares in a fund doesn't mean you should pile in on that basis alone.

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But it is fairly clear that he thinks you should ensure that the interests of the people managing your money are aligned with your own and that probably means checking they holding a decent stake. As Brierley puts it: "there is a marked polarisation, and the apparent lack of conviction by some does not sit easily with the degree of commitment expected by investors. To say, I'm on so many Boards, I couldn't possibly have an investment in all of them' is not an acceptable defence in our view."

Quite. And while the good news is that most directors and managers are fairly well aligned the total investment by investment trust boards and managers in the sector is £1bn Canaccord Genuity's research reveals that 36 current chairmen, each of at least five years' service, own a shareholding valued at less than their annual fee.

Meanwhile, 16% of directors have no personal investment whatsoever I counted eight individuals on annual fees of more than £25,000 who had not invested in their funds. Sure, not all directors should or can invest millions into their fund, but surely a token few thousand isn't too much to ask?

On a more positive note, this treasure trove of data can point us towards funds where the directors and managers own big stakes. In the two tables on the right I've reproduced some of the Canaccord research. The first table shows the directors and chairmen with more than £1m invested in the sector. The second looks at management teams.

In each table, I've only listed the top 20 in terms of total assets owned so be aware that it might miss out promising smaller funds, where the level of total assets under management is very small (so that it's not feasible for the managers and directors to own millions of pounds of shares).

So what do the numbers show us? There are no big surprises. I've long thought that alignment with shareholders matters that's why I've invested in the likes of RIT Capital Partners, Ecofin and Third Point Offshore, all of which are on these lists. But as I said, it isn't an automatic buy signal. I've been a great fan in the past of Hansa Trust, which William Salomon effectively uses as his family trust. It owns some great assets, especially in Brazil. But it's also had its share of challenges, and I'm not sure I'd rate it a buy right now.

The same goes for North Atlantic Smaller Companies Investment Trust. It has a long and honourable record of investing in smaller-cap stocks, and nearly tops one of the lists, with chief executive and investment manager Christopher Mills holding £65m in shares but for my money, it isn't hugely attractive at the current share price.

Four good-quality diversified trusts

RIT Capital Partners (LSE: RCP): this is in effect Lord Rothschild's investment trust. A classic City hold (ie, many City professionals invest in the fund), it's had periods of underperformance and has been known to trade on big discounts. But I think it's back firing on all cylinders as a great 20 to 30-year investment bet.

Personal Assets Trust (LSE: PNL): this is managed by Sebastian Lyon, and directors Frank Rushbrook, Stuart Paul and Robin Angus all hold big stakes. It buys into good-quality firms with long-term potential, as well as asset classes such as bonds and gold, which can help preserve long-term wealth.

BACIT (LSE: BACT): this fund of funds is run by Tom Henderson. It invests in some of the best hedge funds globally, with the aim of preserving capital as well as raising funds for cancer research.

Scottish Mortgage (LSE: SMT): James Anderson's fund adopts an aggressive strategy of ignoring benchmarks and investing in companies capable of disrupting modern business using technology and global reach. If I were a younger investor, I'd be putting all of my money in this fund for the long term.

Four strong specialist trusts

Third Point Offshore (LSE: TPOU): this American hedge fund is a great way to play American assets, but with a value tilt.

JZ Capital Partners (LSE: JZCP): this US-based private-equity house has an excellent long-term track record of investing in mid-sized American corporate assets, and is now expanding globally.

Ecofin Water and Power Opps(LSE: ECWO): this utilities andenergy-focused trust has had a tough few years, but is still relentlessly focused on income-producing utility infrastructure assets. It is also a play on unconventional oil and gas.

Artemis Alpha (LSE: ATS): this is run by John Dodds and Adrian Paterson, effectively as the in-house personal pension fund for this highly respected investment boutique.