A recent study by research firm Morningstar Inc. found that just 40% of mutual fund managers were doing with their own money what they want you to do with yours: invest in their funds. After the report came out, the digital ink flowed on the question of whether mutual fund managers should “eat their own cooking.”
I don’t think there’s much doubt about it. Except in a few well-thought-out cases, money managers should be required by their companies to invest in their own products. I’d go one step further and say that financial advisors ought to have money in the same products they recommend to you.
For years, the savviest investors, top tier endowment managers and the best financial advisors, have been putting money managers to the test, asking: “Do you invest in your own products?”
Then they sit back and wait for the answer, probing further if they need to. David Swensen, the well-regarded CIO for Yale University and author of Unconventional Success, highlights co-investment as one of the characteristics of the best money managers. Some money management firms outline their approach to co-investment directly in their marketing materials. For example, Vulcan Value Partners requires that its products serve as the exclusive public equity investment vehicles for all their employees and the firm “ask(s) no investor to invest where we do not invest ourselves.”
(I’d expect some reasonable exceptions to these kinds of rules, such as for managers whose funds have extremely high minimums, employees who are not qualified investors and therefore could be restricted from private partnership funds, and the 401(k) funds of employees’ spouses.)
The next logical step is to extend this kind of eat-your-own cooking thinking to the advisory world. Financial advisors are the next main group of investment intermediaries, subject to even less transparency than money managers. In his book, The Little Book of Common Sense Investing, John Bogle estimated that Americans spend $400 billion annually on investment intermediaries (both money managers and financial advisors). To put that in perspective, that is more than $1,000 annually for every man, woman and child in the United States.
For that kind of money, investors have the right to ask the tough questions of the people who advise them. This should apply to advisors who are getting paid by commission (i.e. brokers) or by a fee that’s a percent of assets (“fee-only” advisors), or a combination.
Here are a few of those questions:
How does your own risk profile compare with the one you assigned to me?
The answer to this question will allow you to explore and understand whether the advisor used the same critical thinking to assess your risk tolerance as she applied to her own family’s money.
Do you invest in the same products that you are recommending to me?
The answer will help you figure out if the advisor is steering you to investments that aren’t the best-in-class, but for which they receive some kind of distribution kickback through 12b-1 fees, sales loads or marketing arrangements. (See some of our other posts on financial advisor fees.)
If the products are the same, are you and I paying the same fees to buy or own them?
Financial services is riddled with hidden payments and fees. This question will help you decide if you’re being hit with some.
Lastly, can you show me some evidence to back up what you’ve told me?
Ask your advisor for account statements that show her ownership in the investment vehicles that she is recommending for you. The amounts can even be blacked out. But you’d have an assurance that the advisor believes in what she is selling you.
In the investment business, there is an endless amount of talk from people who want to tell you what to do with your money, from the Jim Cramers of the world, to the money managers and on to your financial advisor. The question you should ask yourself is: What do the talkers actually do with their money?
As the immortal Elvis Presley put it “a little less conversation and a little more action.”