Does your fund manager have skin in the game?
In 1956, Warren Buffett raised $105,000 from 11 investors — most of whom were family — for his first fund, himself placing a token sum of $100 as his “skin in the game”.
Over the next 13 years, he grew Buffett Partnerships to $105m, running it “like I run my own money”, and winning the game both for himself and his investors.
Some people believe the phrase “skin in the game” comes from horseracing or gambling, where the owners of the horse have “skin” in “the game”. Others cite Shakespeare’s The Merchant of Venice, in which Shylock stipulates that Antonio must promise a pound of his own flesh as collateral for a loan.
In the US, it’s normal for fund managers to have a stake in funds they manage on behalf of other investors. Indeed, the Securities and Exchange Commission requires fund managers to disclose how much they invest in their own funds “to help investors assess the extent to which the portfolio manager’s interests are aligned with theirs”.
But in the UK, strangely, the practice is still seen as controversial. There’s no relevant regulation, so there’s a huge transparency gap for investors.
Most investors think this is quite wrong. Almost nine out of 10 (88 per cent) of 1,800 retail investors polled this month in a survey for Interactive Investor say it should be mandatory for fund managers to disclose whether they invest in the fund that they manage.
Almost eight in 10 (77 per cent) say they would be more likely to invest in a fund or investment trust if the manager is personally invested in it. Of these, 23 per cent say they have no idea how to find this information.
It is only journalists and investment analysts who are in the privileged position to ask fund managers these difficult but important questions. And there is no obligation for the managers to answer.
Investors interested in skin in the game are reliant on whether fund managers choose to be open about it. Terry Smith is one of the few managers of open-ended funds who has gone on the record on his skin in the game. He announced a stake in his Fundsmith Equity fund and has disclosed stakes in Smithson Investment Trust.
Most fund managers would be crying out if executives in our biggest companies failed to disclose shareholdings. They would be even angrier if there was any suggestion of diluting the rules requiring disclosure.
Providing such information is simply good governance. But for open-ended funds, there are no such reporting obligations or requirements. Annual general meetings, where private investors might have the opportunity to ask questions, are a rarity for open-ended funds.
Investors in listed closed-ended investment companies such as investment trusts have better information on “skin in the game”.
This is because investment companies are listed companies and are governed by the same rules as other listed entities — they have non-executive boards of directors, who have to disclose their shareholdings in annual reports and accounts, and must publish their share dealings.
The same obligations do not apply to the fund managers of listed investment companies (the people responsible for the day-to-day running of the fund). but anyone with a substantial holding does have to report this to the market. For UK-listed investment companies, including investment companies, the threshold starts at 3 per cent.
We also know more about manager stakes among investment trusts, because of the work of analysts at Investec, who publish an annual Skin in the Game report.
Alan Brierley, director of investment companies research at Investec, says: “We strongly believe that personal share ownership sends a clear and powerful message to both existing and potential investors. Since our first Skin in the Game report in 2010, it has become the accepted norm for boards and managers to have a meaningful personal investment in companies that they represent. However, while board directors are required to disclose ownership and transactions, it is disappointing that some managers remain reluctant to do so.”
The Investec report found that 78 investment trusts’ managers or management teams had a combined investment in excess of £1m, while 32 had an aggregate manager or management team investment valued in excess of £10m. It would be good to have this information for all trusts and open-ended funds.
Disclosure aside, not everyone agrees that fund managers should invest in their own funds. In our poll of retail investors, while 85 per cent thought it aligned fund manager interest with their own, 11 per cent thought it could create a conflict of interest and encourage fund managers to take either too little or too much risk.
Also, a manager’s ownership of stakes in their own funds is no guarantee of superior returns. Over the past three years, the two investment trusts with the largest stakes held by their managers, Pershing Square Holdings and Tetragon Financial, have delivered share price returns to investors of +131 per cent and -23 per cent respectively. So no correlation there.
Meanwhile, among open-ended funds, Neil Woodford was an example of a manager who did disclose skin in the game (albeit with few details) but delivered a poor outcome for investors.
So a manager having a personal investment in their fund is not a decisive factor. But it’s a vital part of the picture.
In the US, the SEC requires fund managers to disclose their financial interest by band — rather than the precise amount. The bands are: none, $1-$10,000, $10,001-$50,000, $50,001-$100,000, $100,001-$500,000, $500,001-$1m, and over $1m.
We believe this is sensible and proportionate and call for our UK regulators to follow suit. Investors deserve to know if managers are invested or not, in open and closed-end funds alike. Then they can make up their own mind to put their hard-earned skin in a manager’s game.
Moira O’Neill is head of personal finance at Interactive Investor