Is how much money a manager invests in their own fund really that important?
Should fund managers invest their own money in their funds, and let us know how much? They probably should, says Merryn Somerset Webb. But it might not be the most important thing to know.
Should all fund managers in the UK invest their own money in their funds? And should they tell us just how much money they have invested? There are good reasons to think they should.
Think about how fund management companies make money: their fees are calculated “ad valorem” – as a percentage of the value of the assets they have under management – and are taken directly from your holdings every year. That means that fund managers’ main interest is not so much good performance, but in growing the assets under management; the more they manage the higher the absolute value of the percentage taken.
They can do this in two ways: by performing well, and by using a mixture of marketing and anxiety-inducing PR – you haven’t saved enough to retire on! – to persuade you to invest more.
Given this, you can see why it makes sense to want managers to hold units in their own funds: it makes sure they focus on both getting new money into the fund (which is entirely in their interest) and on making the fund perform well (which is also in our interest).
Good news, then, that this week the Interactive Investor platform has produced a short study into the money invested by the managers of the funds in their Super 60 and Ace 40 lists of rated fund managers.
Nothing is as simple as it first seems
The data is fascinating for what it does tell us – 94% of managers who responded said they were invested in the fund they manage and 24% said those investments came to more than £1m. That’s nice – or at least it’s the answer Interactive Investor would have been hoping for, given that 77% of their users say they would be “more likely to invest in a fund or investment trust if the manager is personally invested in it”.
But it is also interesting for what it does not tell us; some 60% of those polled preferred not to say how much the managers had in the funds and those that did say mostly did so inside ranges – £500,000 to £1m, for example. This might be fine; there are also perfectly good reasons for leaving amounts out of the discussion. You could argue that a manager is already hugely exposed to their own fund (their career and hence long-term income depend on its performance) so it isn’t madly sensible for them to hold too much cash in it as well.
The manager might be better off hedging their exposure by holding a fund that does something they don’t do; markets can be unkind, after all. That’s particularly the case if the manager is in something niche: is it wise to have both your career and pension reliant on a small frontier markets fund, for example? And if they are, might it incentivise you to try to minimise the risk in the fund when your investors (who hold tiny parts of their portfolios in it) want you to max it out.
There’s also the problem of withdrawals: if you know a manager has a million in a fund – and that’s part of the reason you hold it – they’re going to end up having to tell you about their divorce, their school fees or the cost of their mother’s nursing home if they have to take their money out. That seems unfair.
Finally, knowing how much a manager has invested isn’t really much use if you don’t know much about their net worth. Terry Smith of Fundsmith is open about having £250m in the funds he manages – “a substantial proportion of my wealth”. I can believe that – Smith is rich, but £250m is a substantial proportion of most people’s wealth.
But what if you know a manager has £50,000 in their fund? That’s chump change if they’ve been in the business for three decades running a reasonable sized fund that has even vaguely kept up with the market. But it could be a massive stretch – and huge vote of confidence – if they’re 35 with three kids and a whopping mortgage. Again, there’s a bit of oversharing required for the information to be relevant. None of this is simple.
Can a manager have too much money invested?
All that said, I suspect there is one major reason why most fund houses might not want you to know how much their fund managers have invested: not because they mostly have too little, but because, all too often, they have so much that it might give rise to awkward questions.
The key one is how on earth, in a business that is ostensibly highly competitive, can your profit margins be so high that you pay your managers so much that they can afford to have that much money in just one fund (no one holds just one fund)?
The answer, as it has been for decades, is fees. These have been coming down bit by bit; not many managers have the nerve to launch a fund with a fee of more than 1% these days and the big houses make much of regular cuts.
This month Baillie Gifford cut its annual fee on the BG UK Alpha Fund from 0.55% to 0.47% and noted that this marks “the 15th occasion Baillie Gifford has reduced fees across one or more of its range of funds and investment trusts since 2013”.
That’s nice. But Baillie Gifford has nearly $500bn under management. Charge 0.47% on the lot (they don’t – it’s just an example) and your fee income is $2.35bn. Staff costs have historically made up around 56% of fund management costs and the average profit margin for a fund management company is about 35%. There’s real money knocking around here – something that translates into real wealth for fund managers.
On the plus side, we have rather more data on fees than we do on how much managers have invested in their funds – and it also isn’t nearly as complicated. Back in 2016, a study from Morningstar’s Russell Kinnel made it clear that costs are one of the better “proven predictors of future fund performance”.
The cheapest funds were found to be “at least two to three times more likely to succeed than the priciest funds”. That was the case “across virtually every asset class and time period”, something, said Kinnel, that “clearly indicates that investors should keep cost in mind no matter what type of fund they are considering”.
The lesson? Some things are nice to know but complicated to interpret (how much of their own money managers have put into their funds). Other things are vital and simple to interpret (the effects of still-too-high fees). Maybe focus on the latter when you choose a fund.
•This article was first published in the Financial Times