Judging fund managers by whether they invest their own money or not is wrong!

Skin in the game refers to a situation where the major decision makers (in any field) have a personal stake in the decisions that they make. In finance, one example is a fund manager and/or fund management (the fund house) investing their own money in the funds that they manage. I argue that demanding such a requirement is plain unnecessary and wrong.

This is an opinion piece and not my typical fact-based post. So many readers are likely to disagree with this. So I am going to say my say and you are welcome to do the same in the comments section.  Will be happy to learn about angles that I have missed in the following. The title refers to both fund managers and the management (fund house)

Skin in the game has different manifestations and implications in different fields. So let us start with some examples. A: Consider a bus driver. There cannot be bigger skin in the game than this! Every day a driver puts his passenger’s lives on the line, along with his! But does that stop him from driving rashly or disobeying rules? Personal skin in the game has no meaning here! However, if the driver’s daughter boards the bus, how will he drive? Naturally, the child’s presence will make him drive better. So what do we do? Board the bus only when the daughter is present?

B: Consider a teacher. She has a reputation for not knowing much and merely repeat what is mentioned in the textbook. One year she teaches a class with her son in it. Will she suddenly become a better teacher? Or for that matter, consider a competent teacher. Will she become better if she teaches her son’s class?

C:  A chief doctors son gets admitted to the same hospital. The quality of service – room, nursing, paperwork, general upkeep etc. will of higher quality for the son. However, you cannot suddenly enhance the quality of the doctors in the hospital. Perhaps they will prescribe more potent or expensive drugs but their fundamental competence cannot be modified.

Now, each of these examples is quite different.  We can safely assume that the bus driver will operate more carefully if his daughter is on board. However, we cannot assume that this will happen only if his daughter is on board. A driver with a safe reputation is a good bet no matter who travels with them.

A bad teacher cannot become a good one when their children are part of the class. A good teacher is a good teacher no matter who studies with us. Sure, the child may receive some extra attention and extra exercise problems on the side, but she is just being a parent there.

A doctor cannot suddenly find solutions to tricky health issues because someone dear or someone important is the patient. If they can figure it out, they can figure it out for all patients (and only those who can afford will take it up).

skin in the game - Judging fund managers by whether they invest their own money or not is wrong!
Source: http://www.fab.ng/2018/06/dont-return-home-lose-nigeria-maradona-warns-argentinas-coach/

My central line of reasoning here is this: just because a fund manager or the fund house invests their own money in the fund, we cannot assume that they will operate better. This is a false sense of security that we sell to ourselves.

The fund manager (FM) is a trained professional. Her job is to manage the funds as per the scheme mandate decided by the fund house. Will you trust a newbie FM just because she has skin in the game or will you look out for experience first? This is the reason AMCs stress on FM experience when they launch a fund. The proof of the pudding is not in the putting (own money) but in the performance.  If I see the performance, who cares if the FM/AMC have their own money invested?

The FM is also a dispensible professional. FMs job-hop every few years or so. Therefore, I don’t care much for their skin in the game. I need to know if the AMC has a proper process in place where individuals are secondary. They should be saying this when the fund manager is still working with them.

That is responsible governance. Not tossing money into their funds.  Instead, AMCs showcase fund managers when the going is good and when the FM puts in papers, issue a release about how the process is important and how nothing has changed.

Okay, so we have a fund house that insists on skin in the game. So the AMC board members have invested, the FMs have invested and the employees have invested. Question is, how important is the money invested to them?

When you and I invest, we dream about the day we redeem and get huge profits. Emphasis is on: the day we redeem.  So now think of a fund manager who sticks with the same AMC and has skin in the game. How important is the money invested to the FM? Is this money going to be used for important personal goals? Or is this “surplus” cash that the FM does not care about? I think it is safe to say at least the top AMC employees (who we expect “skin” from) have a lot more of “surplus” cash than you and I!

So when we have no idea how important the fund invested is to the management or the employee, how can we claim that skin in the game is important? For all they care, this amount could never be redeemed and invested forever. Now stop and think about it for a moment: We worry about risk, about volatility, about loss only because we know that we need to redeem the money someday.

If we decide to never redeem, then does it matter how much that part of the portfolio moves up or down? This could well be the situation for those who have skin in the game. Well, I don’t know. I am only saying, skin in the game does not mean mere money invested. Skin in the game means dear money invested. As far as I know, such a distinction is not practically possible. Therefore, as a concept, skin in the game means little. What matters is consistent proof of competence (not proof of purchase!). Competence does not or need not depend on skin.

Now, let us assume that the fund houses and employes only invest money that personally matters to them. Take for example a fund that has about 25% skin with a mandate to stay invested in equity all the time. The market has zoomed up and everyone is on edge worried about when the trend will reverse.  First of all, if the FM has dear money in the fund, she should consider a tactical exit. But what if skin in the game is enforced and she decides to increase cash holding in the fund against the fund’s mandate to protect her/their money? What if the bus driver becomes tentative because his kid is on board and makes mistakes?

Well, that is only a crude example. My point is if true skin in the game is supposed to result in better management, then we must also consider the possibility of skin clouding judgement and deviations from an investment strategy.

I would rather look for proper training, experience in handling bull and bear market cycles and reasonably consistent performance. This is definitely possible without skin in the game. Personally, I would only trust an FM or an AMC who has delivered without skin.

Lastly, there is a distinction between skin in the game and walking the talk. We see many people (including yours truly) on websites and social media talk about how one should manage money this way or that way, how that product is bad etc. This implies that I invest the way I shout. Perhaps this one kind of skin in the game, but walking the talk is a better fit. If I say ULIPs are bad, then I must not buy ULIPs. If I preach about stock picking then the major chunk of my portfolio should be in stocks.

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6 thoughts on “Judging fund managers by whether they invest their own money or not is wrong!

  1. Great article! I especially liked how you said that if skin in the game will force a FM to be more careful, it could also force them to be to conservative, so it could be good or bad. Better to target FM experience than skin in the game.

  2. @PattuSir – I would like to share a different perspective.

    The ground truth is that a fund manager and most executives of a fund house are governed by such stringent restrictions laid out by the Securities and Exchange Board of India (Sebi) that despite buying double-baggers and multi-baggers for investors, if they wanted to buy direct equities for themselves, it is difficult to near impossible. Which is why their skin in the game is important, as the same people cannot buy the scrip they are buying or selling via the fund within 15 trading days for themselves and there is some compliance officer approval that is required. (you would know better on this, so please correct me if i am wrong)

    These regulations make it very very hard / near impossible to legally invest their money in direct equity, which is why skin in the game is an important metric.

    Anology: Assume bus drivers CANNOT their children to school in Ola/Uber in routes that they take (to avoid traffic), So they have to send their children in other busses only. And hence a busdriver who decides to take her daughter/son on her bus offers faith to the other passengers.

    1. Fund managers can always choose to do SIP. The same poison that they suggest to millions of others. I am sure getting SEBI approval for SIP in own fund will not be that difficult.

  3. I think having skin in the game is extremely critical in life. The arguments given by the author only try to divert the attention. Do you know what is the difference in approach of an ‘investor’ and an ‘entrepreneur’. There are umpteen examples where an investor or even a strategic investor would leave the table if the goings-on are not ok, whereas an entrepreneur/promoter would fight till his last breath to see that he is able to save onto his business which he built and upon which his survival depends. I recall many discussions at various forums where some fellow employees have expressed that “yaar, hum sabhi ka apna paisa laga he, theek se kam karna, nahi to marva doge”.

  4. I disagree with the interpretation of skin in the game. Here daughter in bus is same as money in mutual fund. Most mutual fund managers still invest in fixed deposits and real estate while claiming others to invest their money in mutual funds. This is ridiculous.

    We all assume when we goto hospital that we get best care, but suddenly if you see the chief surgeon talking on phone about admitting his daughter to the hospital next door we will definitely question his actions in doing so. You should call out things the way they are not try to paint a picture of shades of gray. Recent article about how much fund managers invest in their own funds has spooked all investor and is eye opening.

    1. Your analogy about doctor assumes that your and the doctor’s needs are the same. What if the needs are not the same ?
      For eg. the Chief doctor is admitting her daughter or son in the near by hospital because current hospital doesnt have hair transplant department at all.
      So similarly a MF manager managing a large-cap fund might be investing in micro-caps or unlisted stocks – as they want to take more risk and think that is better for their risk profile.
      A MF manager can be becoming a angel investor for a startup venture (100x return 1000x risk) so if they do not invest in their fund it does not mean that they dont believe in their fund, it could also mean that their _needs_ and risk _profiles_ are different.

      So we should have a balanced perspective.

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