15th October 2021
Alignment of interests is vital when considering where to allocate the wealth that clients have entrusted to our care, but there is no silver bullet to assessing how well a fund manager is aligned with your own interests.
‘Skin in the game’ typically refers to the amount of capital that a fund manager has invested in their own funds, and it is a topic that has gained increasing prominence in recent years both across the closed ended and open ended fund universes.
This week, the financial press has been all over research from Interactive Investor which analysed the investment platform’s Super 60 and Ace 40-rated funds that requested skin in the game disclosures. This study found that of the 82 funds and investment trusts included in the research, 94% of the fund managers had personally invested in their funds.
On the surface, it seems uncontroversial to say that the more a manager has invested in their fund, the better their alignment with achieving positive outcomes for shareholders. The argument being that a high amount of skin in the game suggests that a fund manager will be highly motivated to ensure they deliver strong performance as it is not just their clients’ money on the line, but their own too. Whilst a fund whose manager has no skin in the game should be avoided entirely. If only decision making were so simple…
Whilst we believe that skin in the game is important, a headline figure can often be misleading, and in some circumstances can lead to unintended consequences. Let’s assume you had two funds with identical processes and identical teams, bar the lead fund manager. Fund manager A has £1m invested in their fund. Fund manager B has £100k invested. You might therefore conclude that fund manager A is more motivated to deliver superior returns and may have an incremental edge over manager B as a result. However, what if you then found out that fund manager A has a personal investment portfolio worth £20m, is towards the end of their career and shows signs of coasting towards retirement, whilst fund manager B has their entire personal investment portfolio invested in their fund and is younger and hungrier to establish a strong performance track record? That context has big implications on which is likely to perform better.
Conflicts of interest can sometimes arise if a manager owns too much of a fund too. Looking at investment trusts, it could be the case that a manager owns as much as 30% of the outstanding shares. This gives them the power to block other shareholder proposals and gives them a strong hold over the board whose job it is to act in the best interest of all shareholders.
For investment companies, there is another layer of skin in the game to consider, that of the board of directors that sits above the fund manager with the power to hire and fire them. Suppose you have two identical investment trusts with identical managers and identical boards except for the chairmen. Chairman A has £250k invested in the trust, chairman B £50k. The shares trade on a wide discount and shareholders want the trust to be wound down so that they can benefit from the discount narrowing. Both chairman on the surface would be aligned with investors to wind the trust down as both would see an attractive return on their shareholding. However, what if chairman A is paid £250k a year in cash to be the chair, whilst B is paid just £12,500 a year? Suddenly, the motivation for chairman A to wind the trust down is significantly reduced as they will lose the £250k a year income stream which is large relative to their investment, though chairman B is still likely to be more motivated to push through a wind down in line with other shareholders interests. Context, again, is vital.
Skin in the game is therefore a complex subject far deeper than a headline figure which can often be misleading and tells a very small part of the alignment of interest story.
More important is that a fund manager’s remuneration and career prospects will always be tied to how the funds that they manage perform relative to their objectives. If a fund manager is successful at delivering outcomes that meet their funds objectives consistently, they will enjoy asset growth, be well rewarded financially and will earn respect and commendation from industry peers. If a manager fails to achieve their objectives consistently, their investors will lose faith and take their money back and the manager will risk losing their job. In addition, they will likely struggle to persuade investors in the future to entrust more money to their care – so may even see their career end. Regardless of skin in the game, then, there should be strong alignment of interest.
We are all investors alongside our clients, friends, colleagues and family in our three Funds, and our remuneration is directly tied to how successful we are in achieving each funds objectives. Motivation never dwindles when you get home from the office and your significant other is asking why the Funds unit price was down a couple of basis points that day – even if it had risen every day for the previous month! We are proud custodians of the capital entrusted to our care and do our utmost every single day to ensure that the funds are well positioned to consistently deliver attractive returns for all of our investors, ourselves included.
Dan Cartridge – Assistant Fund Manager
This financial promotion is issued by Hawksmoor Fund Managers which is a trading name of Hawksmoor Investment Management (“Hawksmoor”). Hawksmoor is authorised and regulated by the Financial Conduct Authority. Hawksmoor’s registered office is 2nd Floor Stratus House, Emperor Way, Exeter Business Park, Exeter, Devon EX1 3QS. Company Number: 6307442. This document does not constitute an offer or invitation to any person, nor should its content be interpreted as investment or tax advice for which you should consult your financial adviser and/or accountant. The information and opinions it contains have been compiled or arrived at from sources believed to be reliable at the time and are given in good faith, but no representation is made as to their accuracy, completeness or correctness. Any opinion expressed in this document, whether in general or both on the performance of individual securities and in a wider economic context, represents the views of Hawksmoor at the time of preparation and may be subject to change. Past performance is not a guide to future performance. The value of an investment and any income from it can fall as well as rise as a result of market and currency fluctuations. You may not get back the amount you originally invested. HA4600.