There is a 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.
In India, a few asset management companies employ this principle. Should employees choose to invest in mutual funds, they “are encouraged” or “expected to” invest in the schemes from that AMC.
Now, the regulator has stepped in. A circular released by the Securities and Exchange Board of India (SEBI) on April 28, stated:
- 20% of salary (includes perks, bonus, non-cash compensation net of income tax and statutory contributions like Employees Provident Fund) to be paid in units of mutual fund schemes in which the key employee has a role/oversight.
- The compensation in units will be proportionate to the AUM of schemes in which the key employee has role/oversight. ETFs, overnight funds, index funds and existing close ended schemes will be excluded.
- The units will be locked in for a minimum period of three years or tenure of the scheme whichever is less. Units cannot be redeemed during the lock-in period. But the AMC may provide facility to employee to borrow against the units in case of exigencies. Redemption of units within lock in period will not be allowed on resignation or retirement before attaining superannuation age as defined in the AMC rules.
- To aid diversification of unit holdings, fund managers managing only a single scheme/category of schemes can received 50% of compensation in units via units of the scheme/category managed by him or her. If they choose, the remaining 50% can be paid in units of schemes with comparable or higher risk as per the risk-o-meter.
Frankly, it is no virtue.
Investors are right in principle to expect fund managers to be invested alongside them. It does instil confidence in the investor. Higher investment levels aren't a guarantee of success, neither do they assure you of an ethical or capable fund manager, but at least they show that managers believe in the funds and pay the same costs that the rest of investors do.
Kaustubh Belapurkar, director of fund research at Morningstar India, rightly says that managers investing in their own funds is a good signaling factor for investors. “We do positively view asset managers encouraging/mandating fund managers to invest in their own funds as a good stewardship practice. Having said that, it is worth noting that the individual risk profile of some managers may be different from the risk profile of the scheme(s) they manage.”
It could very simply be that the fund doesn’t suit that manager’s personal situation. There’s no sense in a 30-something manager investing heavily in his short-term bond fund.
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 which may already have exposure to that sector.
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.
Conversely, a fund manager may be heavily invested in his fund. But that doesn’t mean it’s a great fit for your portfolio. A fund manager’s style may be way too aggressive for your liking, even if he has all his savings in the fund, you may still want to steer clear.
Radhika Gupta, managing director and chief executive officer at Edelweiss AMC, articulated her thoughts brilliantly on this issue.
SEBI’s circular on skin in the game is a good idea in spirit, however, it is going to be extremely problematic in implementation.
This circular applies not only to senior employees, but to junior research staff, dealers, and support function heads as well. There is a definite disparity in income between what a chief executive and a chief investment officer earns, as well as in their functions, obligations and responsibilities. Why is everyone clubbed together?
Why are those who earn much less forced to lock 20% of their income for three years? It will definitely hit their savings. An individual earning Rs 15-20 lakh will not be in a position to put away Rs 3-4 lakh with a 3-year lock-in. This will constrain his cash flows.
The circular suggests that we have to invest in all schemes basis weighted AUM. So if I run a 80:20 debt:equity business, that is my forced asset allocation. A mid-cap fund manager has to invest in his schemes or a higher risk grade. What if that does not fit his risk appetite? A liquid fund manager has to park money in liquid for 3 years.
What about a CEO or sales head? Do they have to invest in every single scheme of their respective AMC?
So what are the implications?
- This is going to be very hard to implement.
- We will be forced to pay everyone 20% more, hitting the business and cost structure. A lot of individuals will choose not to work for a mutual fund. Why should a marketing head or sales head or chief technology officer deal with such stipulations? They don’t make investment decisions for the organisation.
- The compensation varies hugely basis the year and bonus outlook. How can these decisions be made at the beginning of the year?
If skin in the game was to be advocated, a simple rule would have done it. Employees earning more than Rs 50 lakh, maybe 50% of your investments (not assets) should be placed in your funds. It actually is much more simple to implement, and logically more sound.
The SEBI circular can be accessed here.