There is a strange term called dogfooding which conveys an impeccable logic. This is it: If you are employed at a dog food company, you should be feeding your dog the same food. Why? Because if the product is as good as your marketing and sales team says it is, you would buy it yourself.
The term dogfooding is now predominantly used as slang by software companies. Developers who do not use their own software on a regular basis are often unable to understand the problems users face. It is tantamount to a sign on the restaurant that says “The owner eats here too”. In the fund industry, it would correspond to whether fund managers have “skin in the game” or “eat their own cooking”, which translates into whether or not they invest in the funds they manage.
Do fund managers in India invest in their own funds?
A lot of them do. A fund manager confessed that in his earlier company, it was mandated that part of his bonus would have to be compulsorily utilized to invest in the AMC’s schemes – a fixed percentage would go into the schemes he was managing and the balance left him with the option to pick up any other fund of the AMC.
Quantum Mutual Fund has always shouted from the rooftops that their fund managers invest in their own funds. A graphical representation is available on their website showing the contribution of the employees against the overall assets. Jimmy Patel, the AMC's CEO, believes that a "fund manager should definitely invest in his fund to experience the effects that his daily calls have on the portfolio and the financial health of all investors who have trusted him with their hard earned savings."
Kotak Mahindra AMC took a stance last year which indicated that should their employees choose to invest in mutual funds, they must invest only in the schemes of the AMC. Nilesh Shah, MD at Kotak Mahindra AMC, believes that “this will make AMC employees personally invested in the quality and quantity of the fund and its performance”.
There are plenty of fund managers who admit to investing in the funds they manage or those of the fund house that employs them. However, they were not obligated to reveal this to the public. That changes now.
The Securities and Exchange Board of India, or SEBI, in a circular issued on March 18, stated that the AMC in its SID must disclose the aggregate investment in the scheme under the following categories:
- AMC’s Board of Directors
- Concerned scheme’s Fund Manager(s)
- Other key managerial personnel
It is not that the regulator has made it mandatory for asset managers to invest in their schemes. They have just stated that it must be made public whether or not they do so.
A fund manager investing in his own fund is an endorsement of sorts and goes a long way in gaining investors’ trust and building confidence. Anthony Heredia, CEO at Baroda Pioneer Asset Management, admits that “investors and distributors could have an increased preference for funds where managers are seen to be significantly invested from a personal standpoint”. And it is there that individuals need to exercise caution.
Investors must realise that they cannot blindly invest in a fund just because a fund manager is heavily invested in it himself. They must do their own due diligence to see if the investment mandate would suit their risk tolerance and capability, whether they are comfortable with volatile or consistent performance, and how the fund fits into their overall portfolio.
On the flip side, they cannot discard options because the fund manager has no investments whatsoever in the fund. For instance, if it is a sector or thematic fund, it may not go with the fund manager’s personal risk profile or may not fit into his own personal portfolio. Ditto in the case of a fund manager of an equity linked savings scheme, or ELSS. He may choose not to invest in the fund simply because he has maxed his limit under Section 80C.
One fund manager confessed that the bulk of his salary goes towards his EMIs and the balance in paying the bills. The amount that he does manage to save goes into a flexi-cap fund into which he has been systematically investing for years. “It’s not that I am not convinced of the fund I manage, but right now I don’t have the financial bandwidth to invest in it”.
So investing in a fund based on whether or not the manager is also invested in it should not be the driving investment decision. It is a positive indicator, but that’s about it.
Vikaas Sachdeva, CEO of Edelweiss AMC, says he does not view this regulation as either a virtue or a vice. “Ideally fund managers should have some amount of skin in the game. But the disclosure of fund manager holdings is being done at an AMC level to the trustees, which is sufficient. Anything more than that adds to the noise”.
Others believe it is a breach of privacy. Their logic being that the fund manager should not be forced to declare how much he has invested in the fund, after all that is his personal portfolio. It should be optional. And investors should anyway be making decisions based on other parameters, not his stake.
Jimmy Patel believes that caution must also be exercised. "There needs to be a limit to which the manager can invest in his own fund – in order to control insider trading. Also, in case of large inflows/outflows from third parties, the fund manager’s additional investment or redemption in the fund should be restricted," he says.
How it has panned out in the U.S…
In the U.S., the Securities and Exchange Commission, or SEC, deemed it mandatory in 2005 for mutual funds to annually disclose the amount the portfolio managers invest in the funds they oversee.
A few years post this regulation, Morningstar reported that 47% of U.S.- stock funds reported no manager ownership, 61% of foreign-stock funds had no ownership, 66% of taxable bond funds had no ownership, 71% of balanced funds put up goose eggs, and 80% of muni funds lacked ownership. Ooops!
At that time, Laura Lutton, speaking to Bloomberg in the capacity of Morningstar's editorial director of fund research, stated that it could be difficult for young managers to invest more than $1 million in their funds, but she has a “hard time understanding why so many managers would not invest anything at all."
Morningstar has always explicitly stated that portfolio managers who invest in the funds they manage show a conviction in their investment approach and a confidence in their investment acumen. They are also better able to share in a true fund holder experience as they endure the same tax and cost consequences as their shareholders.
Morningstar has studied the impact of manager ownership several times, including the 2014 U.S. Mutual Fund Industry Stewardship Survey and 2011 U.S. Stewardship Grade Study. These studies show that funds with managers who “eat their own cooking” by investing alongside their fund holders run funds with better-performing records and lower fees than those with more limited or no co-investment with shareholders. This is particularly true on a risk-adjusted basis, suggesting that managers with a large financial interest in their funds are less likely to take greater risk with the portfolios they oversee.
The studies revealed that mutual fund families with high collective manager ownership coincide with superior firm success ratios. In some cases the margin of victory is slight, but across the board, fund companies with 80%-100% of assets in funds in which at least one manager has more than $1 million invested in his or her fund(s) report the best success ratios. Those in the 0%-20% range tend to have the worst success ratios.
Soon we shall be able to see if such correlations exist in the Indian fund industry.
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