While it's not clear that trusts run by managers with a personal stake achieve better performance, it’s comforting to know your fortunes are aligned.
Even the staunchest allies of the UK’s asset management industry must concede this is a business where the professionals too often get rich even when their clients get poorer. This, after all, is the complaint that has driven the astonishing growth of passive fund management in recent years, as many investors have simply got fed up of paying through the nose for active funds that don’t deliver.
But what if your interests were directly aligned with those of the fund manager looking after your money? This is what is happening at a growing number of investment trusts, new research from the broker Canaccord Genuity reveals. Its study of more than 280 closed-ended investment companies shows the amount personally invested by the managers running them and the directors of their boards has more than trebled over the past six years.
Level of holdings
At the end of April, investment trust directors and managers had holdings worth £2.04 billion in trusts for which they were responsible, Canaccord Genuity’s research shows, up from £687 million in 2012. Fewer than one in 10 directors who had been in post for more than a year had no stake at all in their trusts; comparable figures for managers aren’t available, since trusts don’t have to report this, but the broker found 67 different investment trusts where the management teams had stakes worth more than £1 million.
This, surely, is the ‘skin in the game’ that regulators, policymakers and investor groups alike have been pushing for ever since the financial crisis. They reason that financial services professionals – from fund managers to bankers – are more likely to do a better job of looking after clients’ cash if they know they will suffer in the same way as clients if things go wrong.
Alan Brierley and Ben Newell, the authors of Canaccord Genuity’s research, are certainly convinced this is a good news story. ‘In order to align interests, investors look for directors and managers to have a meaningful personal investment in the companies which they direct and/or manage,’ they report. ‘We have never met one investor who has argued against this, and we strongly believe that skin in the game sends a clear and powerful message to both existing and potential investors.’
All of which is no doubt true, but it does beg an important question – do aligned interests and powerful messages add up to better performance? Not necessarily, is the honest answer. Canaccord Genuity’s research does not explore the link between skin in the game and returns, but Brierley says: ‘I really don’t think it is a guarantee of superior returns’.
Instead, Brierley’s focus is on trust. ‘Investors should take a lot of comfort where a manager has a conviction that means that the fund he [or she] manages forms a core investment in his personal portfolio,’ he says. ‘In many cases I speak with managers where their investment trust forms a significant if not entire component of personal savings.’
Nevertheless, there are several good reasons why fund managers with even very sizeable stakes in their own funds might still serve up disappointing returns to investors. Not least, they might simply be bad fund managers – it’s great to have conviction in your own fund, but what if your faith in yourself is misplaced? In fact, there might be a correlation between conviction and poor performance; several studies comparing the relative performance of male and female fund managers have found the former wanting, usually because they’re too confident in their own abilities, end up trading more often, and rack up costs that drag on performance.
Also, what if your stake in the fund inhibits your ability to make rational decisions? For example, it would be understandable if a fund manager with a large proportion of their wealth tied up in their own funds became more defensive and cautious in their management style, even unwittingly. Imagine, for example, a 60-year-old fund manager running a vehicle investing in highrisk technology companies or emerging markets stocks. Would they find it comfortable making those bets if too many failures could result in them having to delay their retirement?
Also, if the need for diversification is one of the basics of good portfolio management, what should we conclude about a manager who puts all his eggs in one basket by tying his career and personal fortunes together?
In practice, the evidence is mixed. Take four funds where Canaccord Genuity’s research highlights very large management stakes.
At Jupiter European Opportunities (JEO), where manager Alex Darwall has a stake worth £24 million, performance has been remarkably strong. The trust has comfortably beaten its benchmark over short, medium and longer-term periods, and also outperformed the sector in which it resides. It tops its sector over one, three and seven years.
At Troy Income & Growth (TIGT), where manager Francis Brooke has £3 million worth of shares, performance is also impressive. The fund has consistently beaten its benchmark and performs creditably among its peers, even if it hasn’t always beaten the average.
By contrast, Artemis Alpha Trust (ATS), where in April managers John Dodd and Adrian Paterson owned stakes worth £14 million between them, looks much less appealing. Performance has picked up over the past 12 months but looks very disappointing on a long-term basis against both its benchmark and the wider sector.
Similarly, at Caledonia Investments (CLDN), the family-controlled trust where the stakes of chief executive Will Wyatt, finance director Stephen King and executive director Jamie Cayzer-Colvin add up to just over £40 million, returns have been lacklustre. One might also note that this trio enjoy handsome salaries, earning annual fees of more than £1 million each.
Now, there are mitigating factors for both the underperformers. Artemis Alpha has held much larger positions in smaller companies and unlisted businesses than its peers, and these areas of the market have lagged larger stocks in recent years. Still, the trust has felt compelled to recently announce a major shake-up of its strategy, including the departure of Paterson.
At Caledonia Investments, meanwhile, currency market movements, the trust’s large cash holdings and its unquoted stocks have proved to be drags on performance. But, as with Artemis Alpha, while this may be explicable – and while returns may now improve – the large stake held by the executive team has not delivered any outperformance.
Why the focus on trusts where managers and directors have particularly large stakes? Well, on the one hand, in an industry where professionals are often relatively well-off, a small stake may not be material to a fund manager’s overall wealth, in which case their interests are less aligned with investors. As Patrick Connolly, a certified financial planner at adviser Chase de Vere puts it: ‘it is hardly a sign of commitment if a millionaire fund manager simply invests their £20,000 annual Isa allowance into their fund’.
Equally, however, the larger the stake, the more it seems possible that this personal interest will weigh heavily on the fund manager’s mind – in which case, you might see performance suffer from risk aversion, for example.
All in all, independent financial advisers aren’t sold on the value of fund manager stakes as an investment criterion. ‘The interesting ones are where their parents have invested as well,’ says Philippa Gee, the managing director of Philippa Gee Wealth Management. ‘Also, look at where the rest of the team invest, such as the analysts and sales staff ; this is an interesting indicator.’
Sign of commitment
At best, a fund manager stake offers reassurance, adds Connolly. ‘This is a sign of commitment and belief from the manager that they are confident in their own ability and that the fund has positive future prospects,’ he says. ‘But it certainly isn’t a make-or-break deal in deciding whether we will invest on behalf of clients.’
In general terms, Canaccord Genuity’s argument that investors are looking for closer alignment between their interests and those of their fund managers seems fair. But it would be a mistake to depend on this alignment. Some research appears to suggest a link between performance and personal stakes; a report published by Capital Group in 2014 found manager ownership and cost are the two characteristics most strongly correlated with improved returns over 20 years of US mutual fund data. But other data points elsewhere: Morningstar, for example, has shown asset managers running funds with lower fees were more likely to invest in these products.
In the end, what investors are really interested in is the returns in their pockets. If your managers don’t put their money where their mouths are, you have every reason to ask why not. Equally though, the fact your fund manager is suffering alongside you during a period of poor performance is little consolation as you watch rival funds race ahead.