Philip Chao, Principal and Founder of Chao & Company, was recently featured in an InvestmentNews article on how much advisers weigh a manager’s investment in his or her own fund when selecting one. For your convenience, the article is reproduced below, or you can find it online by clicking the following link: http://www.investmentnews.com/article/20150408/FREE/150409923/few-target-date-fund-managers-eat-their-own-cooking#.VSW8pTEH6Ts.mailto
Money continued to pour into target date funds in 2014, but very few of those dollars came from the managers who oversee them.
Last year, nearly $50 billion in net new flows went into target date funds, reflecting an 8% organic growth rate, according to a recent report from Morningstar Inc. The funds, long viewed as the go-to tool for set-it-and-forget-it 401(k) investors, have played a large role in shipping assets to the fund companies themselves, accounting for more than 30% of the net new inflows to their respective fund firms last year.
But success aside, the vast majority of target date fund managers won’t put their money where their mouth is. Out of 57 target date mutual fund series analyzed by Morningstar, 32 have zero personal investment from their fund managers.
“It’s pretty dismal, actually,” said Janet Yang, director of multi-asset class research at Morningstar. Managers investing in their own funds “is one of those things that’s intuitively appreciated.”
In 2014, just two managers invested more than $1 million individually in their own target date funds. Those managers were Bradley Vogt of American Funds and John Cunniff of TIAA-CREF.
But Ms. Yang noted that sometimes there were circumstances barring fund managers from investing in their own funds. Managers at T. Rowe Price and BlackRock, for instance, invest in the collective investment trust versions of their target date funds. Nevertheless, “the fact that more than half of the fund managers don’t invest even one dollar in their own funds speaks for itself,” Ms. Yang said.
Generally, higher levels of manager investment in their own funds tend to coincide with better results, she added.
But when it comes to 401(k) fund recommendations, how much weight do retirement plan advisers give to managers who invest their own dollars in their own funds?
ONE FACTOR AMONG SEVERAL
Retirement plan advisers point to a wide array of factors behind why they recommend one fund family over another to a particular 401(k) client. To some extent, a fund manager’s investment in his or her own mutual fund may play into that. But there are other limitations and considerations.
“From a human basis, you always want to go with those who eat their own cooking,” said Aaron Pottichen, retirement consultant with CLS Partners. “But the challenge with that thought process is that for the most part, we can’t decide which managers are going to be in a target date fund unless you create your own custom target date fund.”
Another thing to consider is that while it’s intuitive for advisers to want to suggest a fund manager who invests in his or her own target date funds, there’s the flipside of the argument: Could they be subject to decisions based on emotion due to the amount of money they have invested?
“When all of my money is in the fund, I can make the point that I’m more emotional about my money and less objective about it,” said Philip Chao, consultant of benefits and investments at Chao & Co.
Advisers noted that while the extent to which a manager has skin in the game is a consideration, they also look at expenses and manager compensation when making recommendations. Mr. Chao, for instance, said the metric used to determine managers’ pay is a bigger deal than whether he or she decides to invest in the fund.
“Is the compensation tied purely to performance? If it’s purely on appreciation, then you may inadvertently take more risk because you want a higher percentage of return vis-a-vis if you’re compensated differently against the benchmark,” Mr. Chao said.
Mr. Pottichen, meanwhile, considered expenses and a given fund family’s fit for a plan’s demographics. “It might make sense to use a fund with a higher equity allocation at age 65,” he said. “We look at the demographics of a group: For people who are older, do they need a more aggressive allocation? Is that provided by the target date fund that we’re recommending?”
Costs remain a big deal. “If I have two target date funds that I’m considering and the manager was invested in one and paid off the performance and the other fund didn’t have those things but was lower cost, I’d go for lower cost,” Mr. Pottichen added.
Separately, some said they couldn’t recommend target date funds without feeling like they were in the game with their 401(k) clients. George Fraser, managing director at Retirement Benefits Group, said he invested all of his 401(k) assets in a target date fund. “If I’m not doing it, then why suggest it for the employees that I’m working with?” he asked.
Though advisers didn’t give a lot of weight to whether target date fund managers invest in their own products, the issue mattered to the managers who partake in that strategy.
Jim Lauder, CEO of Global Index Advisors, a subadviser to Wells Fargo’s Advantage Dow Jones target date funds, invests in the target date fund himself. “If you believe in what you’re doing, then it’s logical that you have some significant funds in your own strategies,” he said. “It should be good for you if you think it’s good for others.”
He added that the Wells Fargo target date series is in fact the qualified default investment alternative in the firm’s retirement plan. “At the end of the day, legions of people invested in target date funds take a step back and see how the organizations are using them,” Mr. Lauder said.