PHBS Research Finds Fund Managers with "Skin in the Game" Benefits Investors More

While vetting portfolio managers might sound like a lot of work, Tang and Ma suggest it is easier than you might expect. They collected data on portfolio manager ownership of 1,610 actively managed U.S. domestic equity mutual funds from 2007-2014. "We find that about 70 percent of our funds sampled have at least one portfolio manager co-investing in the fund, with an average stake of about $540,000." While vetting portfolio managers might sound like a lot of work, Tang and Ma suggest it is...

While vetting portfolio managers might sound like a lot of work, Tang and Ma suggest it is easier than you might expect. They collected data on portfolio manager ownership of 1,610 actively managed U.S. domestic equity mutual funds from 2007-2014. "We find that about 70 percent of our funds sampled have at least one portfolio manager co-investing in the fund, with an average stake of about $540,000."

Analyzing mutual funds' portfolio rebalancing behavior, Tang and Ma constructed measures that capture managers' intended changes in portfolio risk. They found that both intra-year and across-year risk change measures decrease as managerial ownership increases.

They also found that the effect of ownership on risk reduction is particularly strong among portfolio managers with high agency issue-induced risk-taking incentives, like managers who face a more convex flow-performance relation, have poor performance, or are not compensated based on long-term fund performance by the fund management company.

While the mutual fund industry has been shown to have excessive amounts of risk-taking among portfolio managers which hurt investors' welfare, Tang and Ma suggest that the best way to make sure your portfolio continues to produce the returns you desire is to find a manager that invests in the fund they manage. They suggest that fund managers having skin in the game isn't just something that benefits investors, but also is a practice that funds should strongly encourage, if not require.