These managers shun the funds they run.
When Morningstar first constructed the methodology for its Stewardship Grades in 2004, our fund analysts agreed that managers' investments in their funds should be an important component. Managers who hold significant stakes in the funds they run better align their interests with shareholders'; it's a strong incentive to perform well and can also keep managers more cognizant of fees, trading costs, fund size and flexibility, and tax efficiency. Since our Stewardship Grades were first released, the SEC has made the disclosure of fund managers' investments in their funds mandatory (although that information is typically buried in a fund's Statement of Additional Information). And yet, portfolio managers of some sizable funds still don't bother to stash more than a token amount in them. Let's take a closer look at a couple.
Harbor International Growth
We like these funds and their manager Jim Gendelman, but we don't like the investment rules of Marsico Capital Management, which subadvises these and other funds. Gendelman owns shares of Marsico International Opportunities
Marsico's code of ethics expressly forbids its managers from investing in funds they subadvise. The firm maintains that such investments create challenges in compliance monitoring and overseeing employees' investments in the funds.
We're skeptical that such rules are necessary. The managers at the firm are far from the only ones out there who don't invest in funds they subadvise. But there are certainly examples to the contrary. Dick Weiss of Wells Fargo has long invested in the Masters' Select funds that he runs slices of, as do Bill D'Alonzo of Brandywine
Oppenheimer Developing Markets
This is a very different case. Justin Leverenz, who has managed this huge emerging-markets equity fund ($14 billion in assets) since 2007, has done an excellent job at the helm thus far. But he has only a modest investment in the fund--between $50,001and $100,000 as of Aug. 31, 2009. He says he doesn't like the mutual fund incentive structure. Granted, the fund isn't core-holding material, given the volatile nature of the markets in which it invests. But we'd still like to see a bigger commitment. And Leverenz told us recently that he's cut back sharply on his investment in the fund (it may turn out to be zero as of the fund's next filing), and he has a far bigger investment in a personal portfolio of emerging-markets stocks that overlaps with the fund's holdings but is more aggressive in nature.
This situation raises thorny questions. It can be tricky for portfolio managers to move in and out of stocks in their personal portfolios that their funds also hold--the fund should obviously be able to trade first, but the sheer size of this one can push the price of a less-liquid emerging-markets stock up or down significantly. In addition, he has less incentive to push for the fund (one of the biggest actively managed emerging-markets funds around) to close its doors to preserve its flexibility. He's also not paying the fund's 1.43% expense ratio in his own account, as fundholders do.We think he could do a better job of aligning his interests with those of shareholders.
Greg Carlson is a mutual fund analyst with Morningstar.