Are Your Mutual Fund's Watchdogs Eating the Kibble?

As part of the Stewardship Grade for mutual funds, Morningstar regularly looks at how much fund managers invest in the offerings they run. That's because we think managers who invest alongside shareholders signal their conviction in their investment process and in the fees charged.

We think the same logic also applies to the fund board trustees who oversee the offering as shareholders' fiduciary advocates. We think board members who invest in the funds they govern are more likely to advocate for superior management and lower fees.

As part of the board-quality section of the Stewardship Grade, we consider what trustees own collectively in the funds they supervise, but it's telling to dig deeper and see which offerings they own. We think it's possible that fund directors pay closer attention to specific offerings when they have their own money on the line. By the same token, if a fund isn't attractive enough to draw investments from several directors, maybe it isn't good enough for you either. We concede that not every fund in a lineup may be suitable for all directors, given their tolerance for risk and investment goals. Still, we don't think it's unreasonable to expect a diverse group of trustees to collectively spread their investments across each of the funds they oversee.

Lots of Skin in the Game
Some mutual fund boards of directors seem to have acknowledged that investing in each of the funds they oversee can be a signal of conviction. The members of the board that oversees Putnam's funds have invested across the whole family of funds. In a study last month, we uncovered just one director who didn't own one of the firm's 40-odd offerings. Granted, many of these investments appear to be token in nature. (For example, we question why one Illinois-based trustee needs an Arizona municipal-bond fund in her portfolio.) But we like the board's gesture, and we're impressed to see that, taken together, the trustees have invested $87 million in the funds they oversee. Independent chairman John Hill has more than $100,000 parked in more than a dozen Putnam offerings.

The story is similar over at Longleaf. The eight members of that fund family's board have all invested in each of the three offerings they oversee. While that lineup is considerably smaller than Putnam's, we're impressed that all but three of the 24 positions in the Longleaf funds were worth more than $100,000 on Dec. 31, 2005. Those commitments clearly align the directors' personal financial interests with those of Longleaf fundholders.

Less on the Line
Unfortunately, many industry directors haven't made similar widespread commitments to the funds they govern, and the omissions from their portfolios can be telling. At Janus, the firm's fund managers have a solid track record of investing heavily in the funds they manage. But five of the firm's 29 retail funds, including  Janus Fundamental Equity , don't have any buy-in from the board of directors, according to Securities and Exchange Commission filings available in November 2006. Five other Janus funds have only one trustee investor. Janus founder Tom Bailey is the only member of the board who owns shares of the flagship  Janus Fund  . Had more of the fund's directors invested alongside shareholders, they may have been less patient with this large-growth fund's years of underperformance under manager Blaine Rollins. (Rollins left the fund in February 2006, and it's now run by Janus veteran David Corkins.)

Meanwhile, over at Fidelity, board members have invested more than $3 million across a handful of popular core offerings, including  Fidelity Magellan (FMAGX) and  Fidelity Dividend Growth (FDGFX). But their enthusiasm doesn't appear to extend to the firm's sector and regional funds. In fact, 30 of Fidelity's 42 select funds have no trustee ownership. Morningstar has long questioned the usefulness of these ultrafocused funds in one's portfolio, and apparently the trustees also haven't found a role for  Select Communications Equipment ,  Select Defense & Aerospace (FSDAX), Select Materials (FSDPX), or Select Paper & Forest Products  in their portfolios. Perhaps the trustees also would have been less tolerant of Fidelity's frequent manager shuffles at the Select offerings had they been investors in the funds.

Trustee Ownership Isn't a Silver Bullet
Overall, we think widespread trustee ownership is a good thing, but it's no guarantee that a fund will be well run. The Putnam board certainly illustrates this point. Although three of Putnam funds' 12 trustees each have more than $100,000 invested in  Putnam Voyager , the firm's large-growth flagship fund, it has been a laggard since 1999. It's a similar situation with the board that oversees  MFS Massachusetts Investors Growth Stock (MIGFX): Four of that fund's dozen trustees have made investments worth more than $100,000, yet the fund's five-year return is in the large-growth category's bottom third.

And if MFS' board members hold Massachusetts Investors Growth Stock's A shares, like most investors, we're also surprised that they're willing to forgo 0.35% of their assets each year for that fund's 12b-1 fee. If they voted to lower the 12b-1 fee to the industry-standard 0.25%, they'd save at least $400 annually for themselves--not to mention what they'd save for the individual shareholders they represent.

To find out if the trustees representing your holdings have investments along with you, check the offering's Statement of Additional Information on the fund company's Web site or at www.edgar-online.com. And to see how your fund ranks holistically among Morningstar's Stewardship Grades, click  here.