Playing With Skin In The Game

Skin in the game does not refer to a sporting activity in the context of the financial world. Rather, it is about how much trust a fund manager places in the very mutual funds that he promotes to his clients. DSIJ conducted a study to find out if such a practice has any correlation with returns

In investment parlance, words such as trust and faith are quite expensive. It requires a lot of effort and time to get that. Investors should be able to place trust in mutual funds in order for this segment to grow. There are quite a few ways of gaining the trust of investors and one such way is dogfooding. The term dogfooding can be traced to a company making dog food. It means that if you are employed at a dog food company, you should feed your dog the same food. Now the natural question is why? This is because if the product is as good as it is being marketed and sold, then you too would buy it yourself.

What does this mean? It means that you trust your company and its products. This term is also often used in the information technology (IT) space where the employees should be using the same software or apps created by them. This actually increases conviction and trust among its clients. In fact, it also helps the company to understand the flaws in their products in order to improve them. Similarly, when it comes to mutual funds, if the fund managers themselves invest in the funds they manage then it is more likely that they can be empathic enough to understand the investment experience of a mutual fund investor.

Skin in the Game

This leads us to another phrase, skin in the game. This phrase actually originated from derby races, where the owner of the horse has ‘skin in the game’. In the investment space, this term is commonly accredited to Warren Buffett. A book titled ‘Skin in the Game’ authored by Nassim Nicholas Taleb explains the term and its relationship to finance. It essentially points to the investments made in funds that a fund manager may be advising for his clients. In this article we will look at whether having skin in the game makes real sense.

In order to show their commitment in the fast-growing mutual fund industry, executives and managers can talk all they want. However, the real proof of the pudding lies in the taste and so the question is whether they are investing in those very funds that they are promoting. A lot of them do so. In fact, if you visit the website of Quantum Mutual Fund, in the section ‘About Us’, the management says, “We are staunch believers in our investment philosophy and team-driven approach. We are willing to back our belief with action by ourselves investing in the funds that we offer to investors like you.” They have further added, “The fund managers and members of the research team – besides other team members across functions – invest in the funds we manage. Our people believe in – and invest in – our own funds and pay the same costs as you and other unit holders.”

Not just that, but they have also given a graphical representation of how much their people contribute as a percentage of its AUM. Even Kotak Mutual Fund has taken this stance, indicating that its employees invest in mutual fund schemes of Kotak Asset Management Company (AMC). Moreover, even the Securities and Exchange Board of India (SEBI) had issued a circular stating that the AMC in its scheme information document (SID) must disclose the aggregate investment in the scheme under three categories:

✓ AMC’s Board of Directors
✓ Scheme’s fund manager
✓ Other key managerial personnel.

That said, the regulator has not made it mandatory for the AMCs to invest in their schemes. They have just stated that it must be made public whether or not they do so.

The Study In order to understand whether there is correlation between the Board of Directors and fund managers investing in their own funds and its returns, we carried out a study. In this study, we have sorted out the top 10 funds by Board of Directors’ investments in their own funds and top 10 funds by fund managers’ investments. It is to be noted that this has been done by taking the data of the year 2018 to understand its performance till December 2020. Also, only those funds with AUM greater than Rs1,000 crore have been considered.

As can be seen from the above data, there is no correlation between the investment by the Board of Directors and fund managers with that of the returns generated by the fund. In fact, a few of the funds with less investment contribution by the Board of Directors and fund managers have done well and vice versa. There is no clear trend that signifies that a fund with higher contribution by the fund managers or its key personnel performs well.

Conclusion

Dogfooding or having skin in the game, though not mandatory from the regulatory standpoint, is being adopted by various fund houses in order to show conviction in their own investment philosophy and the fund management system. But generally, people try to relate it with that of returns and they might invest with the belief that such funds would perform well. In order to understand the same, we carried out a study. And our study shows that there is no direct correlation between the highest contribution by the fund managers and returns. Therefore, it is advisable for investors not to base their decisions just on the fund managers’ skin in the game. Though it is a good practice to implement, other parameters such as fund’s portfolio, investment style, risk, etc. should also be considered. In short, having skin in the game does increase the investors’ trust in a fund.