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Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.

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Eating their own cooking

"no equity investments by firm employees should be permitted in vehicles other than the funds managed by the firm."

While I'm an advocate for "skin in the game," I disagree with this statement. If firm employees are solely invested in the funds they're managing, their own asset allocations are going to be completely out of wack, generally. These employees would be smart to have some investments in other areas outside of their managed capital. Furthermore, from a comp perspective, they are going to have a lot of that driven by the markets and consequently should not have a large concentration of their net worth also tied up there. That is just poor money management.


  • I disagree with your interpretation of the quoted statement (quoted from where?)

    It suggests that employees should invest only in "funds managed by the firm", not just funds they manage, and not just managers but all employees.

    Regarding employees, it would make more sense to me to confine this restriction to anyone with investing responsibilities, including analysts and traders, but not the cleaning crew, answering service, etc. assuming any of these people are employees.

    In practice, money management firms may have a hard time imposing this policy. A number of firms have been sued over their retirement plans when they have included only house funds. See, e.g. this suit against SEI. Though the Barron's article cited below implies the issue may be more about excessive fees or poor performance; it claims that exclusive use of house funds is in itself okay:

    " the law gives companies wide flexibility to design and run plans as they see fit. Employers aren’t required to select index funds or the lowest-cost shares; they can use their own investment products exclusively."
  • edited January 2019
    @MSF: that's part of a commentary in this month's MFO.

    IMO active fund managers being compensated more with an emphasis on gathering assets for the firm to manage instead of their fund's overall absolute performance is a conflict of interest in my view.
  • edited January 2019
    Thanks for clarifying @msf. That quote from The Observer is a nice sentiment. I get the drift.

    Couple possible exceptions:

    Dealing with the competitors, in relatively small amounts, might be a good way to familiarize oneself with the competition with an eye towards improving your own firm's competitive advantage. How can you really understand how the "interface" between client and firm operates without experiencing the service (or lack there of) first hand? Liken it to a Ford division manager driving autos made by the competition to learn as much about their products as possible (which I've heard is an industry practice).

    The other thought is that there are probably some firms with a rather narrow investment footprint. For instance, they may offer only bond funds or equity funds. In such cases, a firm's offerings might not meet all of the needs of all its employees. T. Rowe doesn't offer a gold & pm fund. Should the manager of one of their bond funds be prevented from buying into a gold fund somewhere else?
  • There are many variants of "eat your own cooking" and many rationales given for it. The suggestion appeared in a paragraph beginning: "Stopping the bleeding is a more difficult question. Have your investors lost faith in you? "

    Barn doors and horses come to mind in this context. Having employees invest exclusively in funds offered by their employer may help sustain investors' faith, but I don't see it restoring faith that has been lost, or stanching the outflows.

    More broadly is the question of whether the purpose of restricting employees from investing outside is to prevent potential conflicts or to eliminate the appearance of conflicts. If one is talking about investors' faith, it seems that it is more the latter.

    To illustrate the difference: a lawyer must withdraw from a case if there is an actual conflict of interest. In contrast, a judge should recuse himself if there even the perception of bias.

    It's not difficult to put rules in place that would prevent actual conflicts. @hank has given examples where a safe exception might be made for outside investing (employees in narrowly focused, boutique firms). That addresses actual conflicts, but not necessarily the appearance of conflicts, certainly not to the same degree. If it is investors' faith that is the issue (and should it be?) then is this sufficient?

    Then there is the reverse consideration - not that other interests would pull a manager in different directions, but rather that having a lot of money invested in the fund being managed would motivate the manager to do a better job, to boost performance. That seems to be @rforno 's focus.

    While this is not entirely without merit, it's something I've long been skeptical of. First, because I have difficulty believing that greater money will spur multi-million dollar earners on. (Will a CEO work better for $20M than for $10M? What about the Protestant work ethic, and what about pride in one's work, regardless of income?) Second, from a personal investing perspective, putting one's eggs in a single basket (more generally, investing in an employer's stock) is not a good idea. Third, you may not get the behavior you want - a manager may not want his own money at risk, so he might manager the fund holding his money too conservatively. Or the manager might increase the risk excessively (since, on average, risk is rewarded, though it often doesn't work out that way).

    I keep thinking about managers who run a company's target date funds. Should they be expected to put money into all the target dates, even though by design only one of the funds is suitable for them?
  • I think Ed's argument might reflect his work with folks whose annual compensation runs into the tens of millions. For most of us, a $20,000,000 payday is hypothetical; for some in the upper tier of the investment industry, that amount can be quickly followed by a list of names.

    The SEC's (antiquated) insider investment ranges top out at $100,000 for directors (some of whom "earn" $300,000+ for their part-time job) and $1,000,000 for managers (some of whom earn, through salary, bonuses, and equity stakes in their firms, tens of millions). With a million dollar investment in their fund, an exceptional year might add $100,000 to their net wealth - i.e., the market plus 1000 bps - or might detract a similar amount.

    And really, how consequential do you suppose that is? And really, how do you suppose the star manager's time gets allocated between the $100 million of personal money in his private partnerships, venture capital investments and his derivatives account versus the $1 million in his mutual fund?

    So the policy with many small equity firms is, you need to have 100% of your equity investments in your employers products. Alternately, some require 100% of investable liquid wealth. Some require all employees, including clerical, to invest and then offer bonuses on the form of fund shares. I've spoken with a lot of managers over the years and I've yet to hear of a stupid policy; that is, Seafarer does not require their employees to invest exclusively in emerging markets which would be disastrous both for the employee and for the adviser, who'd find it impossible to attract talent.

    msf is certainly right about the symbolic importance of such policies. It's sometimes referred to as "the Caesar's wife" problem: it's not enough that you be blameless, you must be known to be blameless. Many of the advisers (i.e., the presidents of firms) I've spoken with are spectacularly dense on all symbolic matters, they persist with the "our job is to invest and let the results speak for themselves." (Fools. There are 8000+ options, each chirping out "look at me," and they think investors will automatically here the $100 million fund's voice clear and sweet about the tumult.)

    Had I mentioned that I just spent the better part of an hour at the gym lifting heavy pieces of metal? Hmmm ... perhaps I need a longer cool-down period.

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