Should Your Investment Manager Have Skin in the Game?

A reader asks:

My job is to run a concentrated 20 company portfolio (all listed companies, buy and hold, long term horizon etc.). I get a base salary and a bonus for performance. So a good amount of my annual earnings are tied to the performance of the companies I pick.

I also have a small personal investment account. My question is around how I should think about investing this – should I use the fact that I spend all of my time researching companies, and invest in those companies for myself, or should I avoid the concentration risk and just go for a passive strategy?

I love questions like this because you could make a compelling argument either way.

On the one hand, it would make sense for you to practice what you preach, have some skin in the game, eat your own cooking, etc. Why should your clients have faith in your strategy if you don’t have your own money invested right alongside them?

On the other hand, if you have all of your money in this strategy you are doubling down on concentration risk. Not only is your career and earning potential tied up in your company, but the strategy itself is concentrated in the number of names you own.

I was thinking about the idea of practicing what you preach when I heard Jimmy Buffett passed away last weekend. I’ve been a Buffett fan for a long time. I wore the Margaritaville t-shirts starting in high school. I went to one of his concerts right after college.1 His music is still on my speakers every summer.

I even read his biography. The guy was a great storyteller with some amazing stories. He really did live it up when he was younger. Drinking until the sun came up. Island hopping. Sleeping on the beach. Sailing. Visiting exotic locations.

Reading through all of the tributes, I was reminded of a New York Times profile from a few years ago called Jimmy Buffett Does Not Live the Jimmy Buffett Lifestyle:

Jimmy Buffett is not really Jimmy Buffett anymore. He hasn’t been for a while. Jimmy Buffett — the nibbling on sponge cake, watching the sun bake, getting drunk and screwing, it’s 5 o’clock somewhere Jimmy Buffett — has been replaced with a well-preserved businessman who is leveraging the Jimmy Buffett of yore in order to keep the Jimmy Buffett of now in the manner to which the old Jimmy Buffett never dreamed he could become accustomed. 

He only occasionally drinks margaritas these days. “I don’t do sugar anymore,” he said. “No sugar and no carbs. Except on Sunday.” He doesn’t smoke pot anymore, either. Now he vapes oils, only sometimes after work.

I had complicated feelings reading about Buffett’s transformation from beach bum to businessman.

At first blush, it felt like false advertising. But then you realize people’s values and responsibilities change over time. The person you were in your 20s is not the person you will become in your 50s, 60s and beyond.

You can change and evolve as an investor over time as well but I do think there is something to be said for eating your own cheeseburgers in paradise.

Morninstar’s Jeff Ptak ran the numbers for me to see how many portfolio managers invest in their own funds.

Out of the nearly 10,300 mutual funds and ETFs in the United States, there are more than 5,900 where the listed portfolio managers own no shares in the fund they manage. The other 4,300 and change have at least one portfolio manager who owns shares of their own fund.

This means close to 60% of funds and ETFs have portfolio managers who don’t own any shares of the funds they’re running. That sounds less than ideal.

I’m not saying you need to have your entire net worth invested in your own strategy but it would be nice if more of these investment managers had at least some skin in the game.

I heard a story once about a well-known quant hedge fund manager who keeps his entire personal portfolio in index funds. The explanation was his entire livelihood is tied up in the quantitative funds he runs for the investment firm he is part-owner of, so he was diversifying.

That makes sense from a career risk perspective but I think it’s hypocritical if you expect clients to invest in strategies you wouldn’t personally invest in.

Do I think you should have all of your money invested in a concentrated portfolio of stocks that also pays your salary and bonus? No.

Do I think you should invest some of your money in your strategy? Yes.

If you’re recommending clients put all of their money into the strategy, you better have a lot of money invested in it too.

But if you’re recommending it makes a nice addition to a diversified portfolio then it would make sense you have a similar investment stance.

Obviously, everyone has a different risk profile and time horizon but I like the idea of practicing what you preach when it comes to investment advice.

I invest the majority of my liquid net worth in the same funds and strategies we use for client portfolios. I do have some other investments for diversification purposes but the bulk of my money is invested just like our clients.

We have a bigger focus on financial planning and asset allocation than a concentrated stock-picking strategy. But I wouldn’t want to give advice to clients I wouldn’t follow myself if I were in their shoes.

We spoke about this question on the latest edition of Ask the Compound:

Barry Ritholtz joined me again this week to discuss questions about when to sell a bond fund, when to sell individual stocks with big gains, the state of the U.S. economy and what to invest in beyond your 401k.

Further Reading:
My Evolution on Asset Allocation

1Such a fun concert. It was essentially a huge party.

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