Why fund managers should share the risk with their investors
Ideally, managers would have a stake in their funds. It might not necessarily lead to better performance, but it would surely make them pay a little more attention.
Does it matter whether your fund manager owns part of the fund he manages? I think we would all say the answer to this is a very firm “yes”. I like the idea that managers are, as Moira O’Neill of Interactive Investor puts it, “eating their own cooking”. You clearly do too: an Interactive Investor survey shows that 70% of people said they would be more likely to invest in a fund if they knew its manager had “skin in the game”.
There is, as Patrick Hosking points out in The Times, not much in the way of hard evidence that this would actually lead to better performance. But it feels as if it should make a difference: if their money is as at risk as ours, then managers should surely pay a little more attention than if it is not (that’s the reason for obliging the CEOs of listed firms to hold shares). Roman engineers were obliged to sleep under the bridges they built, says Hosking: there’s a reason hundreds turned out to be resilient enough that they are still standing (and often still being used) after 2,000 years. There’s also some hope that if fund managers have to go through the processes we go through and get the (mostly shockingly awful) literature we get when we invest, they might break out of their stock-picking silos and put pressure on the wider firm to do better.
That would be nice. However it doesn’t necessarily mean that we should demand managers go “all in”. If you run a fund, you are already hugely exposed to its performance (your reputation and career depend on it doing at least well-ish – and if they don’t, they should). Being overly financially exposed to it doesn’t fit with the diversification mantra the industry (and we) largely live by. They need enough skin in the game to be credible – but not so much that, say, their house deposit savings go down with their fund. Not all fund managers are as rich or as far along in their career as, say, Terry Smith (he and his colleagues at Fundsmith hold £53m worth of their Smithson Investment Trust).
It is possible that most managers already do hold stakes in their funds (I’ve rarely met one who says he does not). But perhaps they should be less coy about it – and be compelled not only to hold some of their fund (nearly 90% of those surveyed by Interactive Investor were keen on this), but also to disclose their holdings. Directors of investment trusts already have to do this and I can tell you from experience (I am a non-executive director of three trusts) that transparency is a great prompt to action. Time for more of it.
Finally, more important than who has or hasn’t got skin in the fund manager game right now is inflation. The Consumer Price Index (CPI) annual inflation rate is now 2.1%. That’s not just higher than expected, but higher than the Bank of England’s target and seven times higher than it was only in November (0.3%). You can argue that much of this simply reflects the economic miseries of the early days of the pandemic distorting the numbers. But there are also things in it that should worry those insisting that these price rises are transient. Look at wage rises, look at commodity prices, look at house prices and you might not be so sure.
This matters – it matters to how fast the real value of your money in the bank is eroded; it matters to the stockmarket; it matters to anyone with debt (in the end interest rates will have to rise), and it matters to house prices. We all have skin in the interest-rate game.