Does skin in the game matter?

Does skin in the game matter? When advisers place clients’ money in a collective investment fund, it can be reassuring to know that the fund’s manager has their own cash in there too – intuitively, it seems to make sense that they’ll be even more focused on the task of driving returns if their own wealth is at stake.

There are counter arguments, of course. One is that managers with their own money in a fund might take too cautious – or too adventurous – a view, allowing their emotions to cloud their judgement. Another point is that from a diversification point of view, putting your savings and your earnings potential in the same basket might not make good sense; savvy managers ought to recognise that.

Still, the consensus amongst investment advisers is that skin in the game is to be welcomed. And it is a pretty common phenomenon. Research just published by the investment platform interactive investor looked at 82 funds on its recommended funds lists – of those, 77 said the manager held a personal investment, and only three said not (the other two declined to answer). Leading fund managers, it appears, are routinely staking their own cash.

interactive investor’s survey spanned open-ended funds and investment companies, with managers of both types of vehicle making personal investments. However, there is one important difference worth noting: different rules on reporting and disclosure make it much more straightforward to track what’s going on in the investment companies sector.

Currently, open-ended funds are under no obligation to disclose whether their manager holds a stake. By contrast, investment companies, listed on the stock exchange, are bound by more exacting reporting rules. For one thing, they have non-executive directors, with a statutory duty to disclose their shareholdings in each year’s report and accounts. Non-executives must also disclose details of their trading in the fund under the directors’ dealings rules. And while managers are not covered by these requirements, any individual with a holding of more than 3% in the fund must declare that to the market.

For those who believe transparency is important, this distinction is significant. It is also a reminder of the different status of open-ended funds and investment companies. The former are products, designed by investment management firms to be sold to investors. An investment company, on the other hand, is an independent entity, with legal safeguards intended to ensure it is run for the benefit of shareholders. The disclosure rules related to skin in the game are just one element of that.

In the US, by the way, the Securities and Exchange Commission requires all fund managers to say publicly whether they have invested in their own funds – and even to give an idea of how much. interactive investor thinks similar rules should be introduced in the UK.

In the meantime, however, for advisers and investors who feel this issue is important, it remains much easier to get meaningful information from investment companies. That is not the same thing as superior performance, of course, but if you believe in the link between skin in the game and outsized returns, investment companies will make it simple for you to explore it further.