Skin in the game

Directors must disclose their personal holdings in their investment companies. Should fund managers too?

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Directors must disclose their personal holdings in their investment companies. Should fund managers too?

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Do investment funds where the manager has a personal investment perform more strongly? There is actually surprisingly little substantive research available to answer this question, though a Harvard paper in 2009 did find that mutual funds where directors did not own stakes tended to underperform.

Still, most of us would be pleased to see the manager of the funds in which we invest putting in their own money. After all, if our fund managers do not have the confidence to invest, why should we? And it seems intuitively reasonable that a manager with a personal stake in a fund is going to raise their game.

This is the debate underpinning a lively argument in the investment industry in recent weeks. The investment platform Interactive Investor thinks fund managers should be under a regulatory obligation to disclose whether – and how much - they invest in their own funds. Some in the industry even think managers should be obliged to take a minimum stake.

The latter is a more extreme argument. After all, managers’ interests are aligned to their funds even without a stake, since their continued employment and career prospects depend on how good a job they do. Still, the disclosure call is harder to bat away – investors surely have a right to know whether their managers have any “skin in the game”.

Interestingly, the broker Investec has just published its bi-annual survey of the investment company industry’s record in this regard. It welcomes its findings that share purchases in their own funds made by board and fund managers have increased seven-fold over the past decade.

More than nine in 10 investment company directors who have been in post since 2019 – giving them long enough to invest – hold shares in their funds, Investec reports. However, it is unable to provide a similar analysis of fund managers in the industry; while directors are statutorily obliged to declare their stakes, managers do not have to do so (though many are quite happy to publish their interests).

Investec’s own view on skin in the game is pretty unequivocal. It is important that “directors have some of their personal wealth in the investment trust”, it says. The effect is to align the interests of those with the fiduciary responsibility for the fund with those who invest in it.

In fact, a number of investment companies actually require their directors to invest as a condition of their appointment to the board. Indeed, the top-performing Scottish Mortgage is currently seeking permission from shareholders to alter its rules, because an unintended effect of a restructuring at the fund now requires new directors to stump up a whacking £57,000.

It seems unlikely that investment companies would require their managers – who are employees of investment managers appointed as third-party service providers to the fund – to buy minimum stakes. But even in the absence of the regulatory intervention that Interactive Investor is calling for, boards could require their managers to disclose what stakes they hold. That seems like a basic issue of transparency.

Indeed, this debate is another opportunity for investment companies to underline the advantages of their ownership structure. The fact that an investment company is an independent, stock-market listed company – with all the legal duties to safeguard the interests of shareholders that this entails – is an important point of differentiation. By contrast, open-ended funds are products launched by investment management firms – and therefore ultimately run in their interests.

Investment company directors’ disclosure of their shareholdings hammers home this distinction. Extending the requirement to fund managers would be the cherry on the cake.