Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Does heavy manager ownership lead to better fund performance? Joining me to discuss his latest research on that topic is Russ Kinnel. He is director of manager research for Morningstar.
Russ, thank you so much for being here.
Russ Kinnel: Good to be here.
Benz: So, Russ, your Morningstar FundInvestor cover story looks at the connection between manager ownership and fund performance. First of all, let's talk about where, if investors want to do their own homework on this, they can find information about how heavily the manager might own his or her fund.
Kinnel: You find it in the Statement of Additional Information--the SAI. On Morningstar.com, if you go to the Filings tab, you'll see that as one of the options. There, you'll find in that filing how much the managers own in the fund. They're displayed in bands. The SEC requires these bands. So, it could be $1,000 to $10,000 or $100,000 to $500,000. The maximum limit is over $1 million.
Benz: So, the manager could have a lot more than that, but it would just show that they are in that over $1 million band.
Kinnel: That's right. Or, [for instance,] in the $100,000 to $500,000 band, you don't know if it's $100,001 or $499,000.
Benz: Got it. And you think that the SEC could actually tell a more meaningful story by doing a different kind disclosure. Let's talk about what you think would be a better way to display this information.
Kinnel: That's right. Why not just tell us the total number of shares the manager owns in the fund rather than use these vague bands? If I own stock in a company, I can see how many shares the CEO owns. They don't say, "Over $1 million worth of stock." And the reason I think that's important is that, one, you know the precise amount. You can see if they're buying or selling. But, two, a lot of portfolio managers make a lot of money; a few of them are on the billionaires list. Bill Gross is probably worth a couple of billion dollars. So, for some managers, that's really not necessarily that big of a commitment. I think it's a good indicator of commitment. And certainly, with so many managers who have zero dollars in their funds, it's helpful to weed out those with major commitment versus those with none. But you could still do a lot better than that.
Benz: So, let's talk about your study, your recent research into this topic, looking at the connection between manager ownership and performance. Let's talk about how you measure success. So, what is your version of success for this study?
Kinnel: What I look at is if a fund has outperformed and survived. The reason for doing that is that, over time, a lot of funds get killed off. So, if you don't include that survivorship element, it can really skew the data, especially if one part of a fund group is more likely to be killed off than another. So, that's a way of incorporating both things. If you think about it, that's what most people would consider a success: This fund survived and outperformed. Most funds that don't survive are merged away. Many are merged away because of poor performance--not all of them, but most of them.
Benz: So, outperformed its peer group--its category peers?
Kinnel: That's right. Peer group.
Benz: OK. So, you've been looking at this issue for a while now. You had run a previous study looking at the funds in the Morningstar 500, which are featured within Morningstar FundInvestor. You opened it up to a broader universe for this particular study. In the previous study, you found kind of a mild correlation with heavy manager ownership and better performance. In this study, you really found quite a bit of predictive power from manager ownership. Let's dive into the details a little bit.
Kinnel: That's right. I think the reason that it was more pronounced with this broader group is that the Morningstar 500 is already a hand-selected above-average group. They are not all buys, but they are big funds. They are generally very good funds that I think are worth paying attention to. So, you've kind of already screened out a lot of the weaker players, whereas if you look at the broad universe, you've got everyone in there. And there, the impact of manager ownership is more pronounced.
Benz: So, when you looked at that top band where managers had more than $1 million in their own funds, you found that those funds tended to have better success ratios than the others.
Kinnel: That's right. So, funds where managers invest over $1 million had a success rate of 48% versus [funds where managers invest] zero dollars, which was about 32%. And then all the levels in between pretty much went consistently stair-step up along the way, which indicates we're on to something. What we did was we looked at ownership levels from five years ago and then performance over the ensuing five years to test out whether you would have had improved results if you had chosen along the lines of manager ownership, and it looks like you would have.
Benz: You noticed, though, in certain asset classes that there seemed to be a stronger signal that manager ownership was actually a better predictor than in other asset classes. Let's talk about that a little bit.
Kinnel: In domestic equity and international equity, we saw very strong predictive power. In some other areas, it wasn't as strong--taxable bonds and sector funds, in particular. I'm not certain why that is. One reason might be simply that there aren't a lot of managers with over $1 million invested in their funds in those two groups--or at least there weren't five years ago. So, it may be simply limited data, or maybe the sector group is quirky enough that it's not as meaningful. We'll have to gather a little more data or we'll need a little more time really to sort that out.
Benz: So, preliminarily at least, it does appear to be somewhat connected. Let's talk about a few funds or shops where the managers really do have an exemplary record of eating their own cooking.
Kinnel: I think there are some places where you see, just about across the board, basically every manager has over $1 million in every fund. So, that makes it easy for an investor to go right there and find some managers who are committed to their shareholders. I think of Dodge & Cox, where virtually every manager has over $1 million [invested]. Longleaf Partners, virtually every manager. We've heard Mason Hawkins say that just about all of his net worth is in the funds he runs. And I think you really see some strong performance as well from these firms. I guess Longleaf has had some bumps in the road, but I don't think it's from a lack of commitment or looking for short-term success.
Benz: And Primecap you also think is a firm that exemplifies this.
Kinnel: Primecap is another one where you'll see managers with a lot invested. And another element you see in all three of these firms is that managers tend to stay there for their entire careers. So, I think another way of looking at that commitment is if you're there for your whole career, obviously you buy into that strategy. You really see that with these three firms.
Benz: Russ, some fascinating research here. It stands to reason that managers who buy their own funds would tend to perform better, and your research does seem to support that. Thank you for sharing it with us.
Kinnel: You're welcome.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.
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