Some Funds Stress Managers' Personal Stakes

Managers, though, can take that one step further. They can put their money where their mouths are by investing alongside loyal shareholders. There is no surer sign of conviction than the size of the personal stake managers have in the funds they run. And thanks to new regulations finding that information is as easy as paging through a fund's Statement of Additional Information.

This week Morningstar put particular emphasis on manager conviction when it released insider ownership data on thousands of funds. What the fund-tracking company found was surprising — and a bit disheartening, too. Almost half the managers of U.S. stock funds have none of their own money at stake. It's worse for international offerings: 61% of those managers decided all of their money was better served elsewhere. With the exception of a few caveats discussed below, "I can't think of why anyone should invest in a fund that its own manager doesn't invest in," says Russel Kinnel, Morningstar's director of mutual fund research.

Is he right? Well, there is no conclusive link between insider ownership and performance. Indeed, the stock market doesn't care whether the manager has skin in the game. There are plenty of bad funds with managers for whom investing their own money is just one more bad decision. Better in the end to decide purchases based on low fees, long-term performance and a manager's resume.

That said Morningstar did find that its analyst picks — highly-rated funds that have low fees, strong performance and good stewardship — had managers at the helm who had invested an average of $354,000 of their own money. That was seven times the amount of the company's analyst pans, the funds with high costs and poor strategies.

So it makes sense to at least consider insider ownership when looking at other criteria. It's a clear sign that a manager's interests are closely aligned with those of shareholders. When managers invest their own money, they have an additional incentive to keep costs down and taxes to a minimum. After all, they don't want a bill from Uncle Sam, either. It's also comforting to know that a manager — and some of these guys are easily making more than $1 million a year — is experiencing the same ups and downs in their account balances as the rest of us. Indeed, the indictment unsealed Thursday against two former Bear Stearns hedge fund managers alleges that they misled investors in the funds, which were eventually liquidated, on this crucial point. "Ralph and I each have about 40% of our non-real estate net worth in the fund. I am adding more this month," one of the managers allegedly told clients. He never followed through, prosecutors charge.

Of course, there are certain situations where managers shouldn't be expected to put a lot of money on the line. Kinnel points out two: If a manager is running a single-state bond fund focused on an area where he doesn't live, it doesn't make sense for him from a tax perspective to invest in it; some foreign managers may be based in countries that prohibit investing in U.S.-domiciled funds. We would add a couple of others to that list. A manager who runs a narrowly focused fixed-income or stock fund — say financial services or ultra-short bonds — could be forgiven for having the bulk of his wealth in a more diversified offering. That's just Investing 101.

"Anyone who gave [the manager] financial advice would tell him to do that," says Barry Korb, president of Lighthouse Financial Planning in Potomac, Md.

There are some fund families that have embraced insider ownership. Janus has seen its fair share of controversy over the last decade. To regain shareholder confidence, it has put emphasis on managers investing in the funds run by the firm. The Denver-based shop known for growth investing says 30 of its managers combined have well over $22 million in their funds and in others throughout the fund family. Tweedy, Browne mentions on its web site that the company's employees, its current and retired principals and their families have over $670 million of their own money sitting in the company's funds. The managers at Davis Funds also have a reputation for having large insider ownership stakes.

"We use a bunch of criteria to evaluate a team of managers and we think ownership — or eating one's own cooking — is a pretty useful measurement," says Corey Vertich, a principal at Uhler & Vertich, a wealth management firm in Fort Myers, Fla. He thinks it's easy to equate big insider ownership with well-run fund families. "The Davis funds are living examples of that."

Below are five funds whose managers, according to Morningstar, have over $1 million invested in the funds. These offerings also happen to charge low fees and have great long-term track records. And that may be no coincidence.