NEW YORK -- Would you eat at a restaurant where the chefs didn't eat their own cooking? Would you have joined the Hair Club if the president weren't also a client? Then why would you invest in a mutual fund where the managers don't put their own money alongside yours?
That's what a growing number of managers are asking. They invest their own savings in their funds, which they say makes them more in tune with investors' interests. Mutual fund managers aren't required to invest in their own funds, and they can still perform well without doing so. But it's encouraging for investors to see that the manager believes enough in the fund to put his or her own money on the line, proponents say.
"It gives you a peace of mind that the people running the fund have their interests aligned with yours," says Charlie Smith, chief investment officer of Fort Pitt Capital Group. He says 90 percent of his total net worth is invested in the Fort Pitt Capital Total Return fund (FPCGX).
"It's a good signal that at least you're getting something where you're not getting flim-flammed," he says. "And there's enough flim-flammery out there."
Only 49 percent of mutual funds have at least one manager who has invested in the fund, according to data provided by Morningstar. The Securities and Exchange Commission has required mutual-fund managers to report how much they have invested in their own funds since 2005. That means investors can't yet measure 10-year track records of funds with high manager ownership against those with none.
But over the last five years, funds with high ownership by managers have done better as a group. Consider mutual funds where at least one manager has more than $1 million invested in the fund: They have returned an average of 9.1 percent annually, versus 6.5 percent for funds with zero manager ownership.
To see if a manager has invested in a mutual fund, investors can look at the fund's Statement of Additional Information. Fund companies will often include a link to this on their websites, along with the fund's prospectus and other documents. The statement will give a range of how much the manager has invested in the fund. The ranges, though, are quite broad, such as $50,001 to $100,000 or $500,000 to $1 million. For Fort Pitt Capital's Smith, the Total Return fund's statement says that he has more than $1 million in the fund.
Smith says that it's only fair that he invest in his own fund: It dovetails with his philosophy on stock picking. He likes to buy stocks where the chief executive officer and other managers have big stakes in the companies themselves, like Loews (L), which is run by the Tisch family. The thought is that managers who also own lots of stock will be better stewards of shareholders' money.
Smith's Fort Pitt Capital Total Return fund invests in a mix of big U.S. stocks and bonds. These kinds of funds - along with large-cap U.S. stock mutual funds, intermediate-term bond mutual funds and other core mutual-fund holdings - are where a manager's ownership is particularly telling, says Russel Kinnel, director of mutual fund research at Morningstar.
"It tells you if the manager really believes in the concept," Kinnel says. "Sometimes funds come into existence because someone in marketing thinks it's a really good idea, and the manager may be going along only half-heartedly."
To be sure, it's unfair to expect every manager to own big stakes in his or her mutual fund. Sometimes a manager may not be a U.S. citizen and is barred from owning a U.S. mutual fund. Target-date retirement mutual funds may also see less ownership by managers, particularly if a 55-year-old manager is running a fund aimed at savers in their 20s.
Mutual funds that invest in esoteric niches of the market, such as municipal bonds from a single state or stocks from a single developing economy, are also less likely to see big ownership by their managers. They can be riskier investments, and an investor wouldn't want too much of his or her portfolio concentrated in them. Other times, managers may have nothing in the mutual fund they run, but they're invested in separate accounts at the firm run with the same philosophy.
Mark Travis, who manages the Intrepid Capital fund (ICMBX), says having nearly all of his net worth invested in Intrepid mutual funds doesn't change his day-to-day investment behavior much.
He says he would buy stocks when he thinks they're cheap and sell them when they're expensive, regardless. But he says being an investor in the fund gives him added appreciation for keeping trading expenses low and limiting investors' tax bills.
Given all the minutiae covered by new regulations for the financial industry, Travis says he is surprised that one of them wasn't to force managers to own stakes in their own mutual funds. "I just think to have a fund manager doing something different with his money than he's doing for his shareholder, I scratch my head at that."