Does Your Fund Manager Feel Your Pain?
Less than half earn credit for fund ownership in our Stewardship Grades.
Morningstar recently examined whether fund managers invest in the offerings they run, and our study revealed that skippers of most U.S.-stock funds have none of their own money invested alongside shareholders. This latest study, which examines fund manager ownership throughout the industry, reinforces what we've found through our work on Morningstar's Stewardship Grades for mutual funds: Most mutual fund managers' own financial interests are not well-aligned with shareholders'.
Morningstar has issued Stewardship Grades to more than 1,000 individual mutual funds, and as part of our methodology, we look at a fund manager's financial interests to see if they're synched up with fundholders'. As part of the Fund Manager Incentives section of the grade, we research whether fund managers invest meaningfully in the offerings they run, because managers who own fund shares are more likely to act in shareholders' best interests.
Beginning in 2005, the Securities and Exchange Commission required funds to disclose annually each manager's stake in every fund they run. Those investments are disclosed in ranges: 0; $1-$10,000; $10,001 to $50,000; $50,001 to $100,000; $100,001 to $500,000; $500,000 to $1 million; and over $1 million. To receive full credit for the manager-ownership portion of the Stewardship Grade (which represents up to 10% of the fund's overall grade), a manager of a core mutual fund should invest more than $1 million of his or her own money in the fund. That's an industry best practice and a high hurdle, but it's not unreasonable--fund managers commonly earn millions per year.
Our ownership standards are lower when managers run non-core funds, such as sector, regional, or cashlike offerings. We also are forgiving of managers who run single-state municipal bond funds, but don't live in the state in which their fund invests. In those cases, managers can earn credit toward a fund's Stewardship Grade by investing in their home state's muni-bond fund or a national muni offering. Such funds can also earn credit if the manager has a substantial investment across the fund shop as a whole because that signals conviction in the asset manager's investment process.
So how many funds pass our manager-ownership test? Less than half of the 1,066 funds we grade receive at least some credit for manager ownership. About 20% receive partial credit and 24% receive full credit, with the rest earning no points toward their overall Stewardship Grades. That's disappointing because we grade primarily the industry's largest and best offerings. If managers aren't making meaningful investments in these funds, it should give investors pause.
Whether a manager has made a large commitment to his or her fund may depend more on where he or she works than on the fund's asset class or mandate. Funds we grade from the Dodge & Cox, FPA, Oakmark, Royce, and Weitz families all get full credit for manager ownership. On the flip side, the ownership scores tend to be weak at funds we grade from shops such as JP Morgan, Putnam, and Vanguard.
We've heard lots of reasons why managers don't invest more in the funds they run. Some argue that managers' compensation--and career success--depends largely on their ability to generate strong long-term returns for shareholders, so they have plenty of incentive to do well. Others have pointed out that managers often have access to cheaper, tax-advantaged versions of their strategies, such as separately managed accounts, and ownership of those investments isn't disclosed to the SEC.
Both of those things may be true, but the best way to demonstrate a commitment to shareholders is to join them. Some of this industry's most-admired managers have invested millions of their own savings alongside fundholders', so they're subject to the same fees, taxable events, and volatility as those who have entrusted their life savings to the mutual fund. They're also showing conviction in their investment process. If managers aren't willing to put a significant portion of their own money into their mutual fund, why should you?
To find out how well your fund scores for manager incentives and overall Stewardship, Morningstar.com's Premium subscribers may click here. To get more detail on the managers' ownership of fund shares, be sure to click through to the text associated with each fund's Stewardship Grade. We discuss manager ownership in the Manager Incentives section of the grade.