Guest Post: Cale Smith's Eating Your Own Cooking

My pal Cale Smith of the fantastic Cale in the Keys blog is an Islamorada-based portfolio manager.  Below is a recent missive of his about how mutual fund managers who own their own funds outperform.

A great read from a great writer.  Enjoy!

Eating Your Own Cooking

Imagine you’re eating a glorious blackened mahi sandwich here in Islamorada. You step outside to take a call from your significant other, reminding you to pick up some grits. You wander around the building a bit, then come across the chef – sitting out back, eating Burger King.

I’m guessing your first thought will probably be, “Why isn’t that guy eating his own food?”

Mutual funds act the same way. While investors will look at past performance, Morningstar ratings, and manager tenure, they rarely consider how much money a portfolio manager has invested in the fund he manages. Does that guy eat his own cooking?

Mutual fund ownership statistics aren’t by any means complete, but we know that about half of fund managers own less than $100,000 of the funds they manage. And only about 25% of managers invest more than $500,000 in the funds they run.

Does it make a difference? I say it certainly does – and so does an autumn 2008 article in Financial Management magazine. Its author, Allison Evans, an assistant professor of accounting at Wake Forest, did an exhaustive study of mutual fund manager ownership and performance from 2001-2004. She found the following:

1. Managers that were only minimally invested in their fund had lower returns – approximately 2.6% lower. With ownership comes motivation, it would seem.

2. Managers with less invested also bought and sold shares more often. This is referred to as turnover, and it eats away at returns through taxes and commissions – important things…that apparently seem less important to a manager that has no skin in the game.

Portfolio managers who have nothing invested in the funds they manage are like cooks who have dinner delivered to the restaurant’s back door. They don’t eat their own cooking, and that’s probably something you’d want to know before you invest, isn’t it? I can’t imaging buying a Ford from a guy driving a Chevy, or buying an Android phone from a guy using an iPhone.

So why would you buy a fund managed by someone who invests his own money somewhere else?

Source:

Eating Your Own Cooking (Cale in the Keys)

Read Also:

Cale’s Favorite Quotes from the Berkshire Meeting (TRB)

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