Skin-In-The-Game Investing: Why It Matters by Frank Holmes
Seven hundred forty million dollars.
That’s how much Bill Gross has reportedly invested of his own cash into the bond fund he manages at Janus Capital Group. The billionaire bond king—who unexpectedly left Pacific Investment Management Company, or PIMCO, in September after a clash with senior management—now owns a little over half of the $1.45 billion fund.
This is likely the most extreme case to be found of a portfolio manager investing in his own fund—or “eating his own cooking”—but it’s certainly not the only one.
Jackson Park Capital money manager Greg Jackson also has millions personally tied up in one of his firm’s funds. He likes to tell investors that when they go shopping for a fund, one of the decisive factors should be whether the manager invests in it himself. This shows that the manager has faith and conviction in the product.
“If I were a shareholder, that would give me pause [if the manager weren’t invested],” Jackson says. “Why is the fund good enough for me but not good enough for them?”
“A recent Wall Street Journal article takes the advice even further: “In the end, knowing that the manager has skin in the game isn’t the sole reason to choose a fund, but it makes sense as a basic criterion or a tiebreaker for selecting between two funds.”
Following this line of thought, Jackson is attracted to companies whose CEOs, officers and other corporate insiders are bullish on their own stock.
“You care a lot more if there’s skin in the game,” Jackson says.
This sentiment is shared by Catalyst Funds portfolio manager David Miller, who even designed a fund that seeks to invest only in companies whose officers are buying shares of their own stock on the open market.
“There are some strong correlations between what the insiders are doing, where the stock is going and its future thereafter,” Miller explains. “They know whether there are going to be earnings or if a company will be acquired. You can also see what they are actually doing with their own personal funds.”
Take Elon Musk, founder and CEO of Tesla Motors, which we own in our Holmes Macro Trends Fund (MEGAX). On May 30, 2013, Musk purchased over $100 million worth of his own company’s stock. Since then, it’s climbed more than 100 percent, compared to the S&P 500 Index’s return of 27 percent.
You do the math of how much Musk has made on his investment.
Consider also Warren Buffett. Writing in the Berkshire Hathaway owner’s manual, Buffett reassures shareholders that “most of our directors have a major portion of their net worth invested in the company. We eat our own cooking.”
Speaking of Buffett, his annual letters to shareholders are always a treat, full of wit and wisdom that only someone of his brilliance and investing experience can articulate. The fiftieth anniversary letter was just released, which you can read here.
More recently, 89-year-old entrepreneur and philanthropist Alfred Mann altruistically put up $1 billion of his own capital to keep afloat his company MannKind, which manufacturers the groundbreaking Afrezza, an insulin treatment that diabetics inhale instead of inject. Mann is also involved with Second Sight Medical, which IPO’d in November. The company makes and sells advanced retinal implants that restore partial vision to the blind.
In October of last year, the Financial Times wrote: “Equity investors like to see that the chief executives of the companies in which they invest have a decent shareholding; they like to see remuneration packages that include lots of stock compensation.”
Simply put, any kind of insider buying is typically a good sign. As Investopedia explains:
Executives can talk all they want, but the best vote of confidence is putting one’s own money on the line just like outside investors!
Walking the Walk
At U.S. Global Investors, we not only share this philosophy but also practice it. Like Gross, Musk and Buffett, we have skin in the game, an expression that Buffett is often credited with coining.
More to the point, whenever one of our portfolio managers receives a performance bonus, half of it he gets in cash while the other half goes directly into the fund he manages.
As for myself, I’m invested in all nine of our funds, the most significant position being in our Near-Term Tax Free Fund (NEARX). On top of that, I’m also a U.S. Global Investors (GROW) shareholder. The information in the chart to the right is taken from our statement of additional information (SAI), and reflects that every one of our funds has at least $50,000 in portfolio management ownership.
I believe it’s absolutely essential for our investment team, officers and I to have some skin in the game, to eat our own cooking, to feel the pinch when a fund disappoints and the exhilaration when it outperforms. Because we face the very same risks and rewards that our investors do, we’re motivated and incentivized to exert greater care and effort into the management of our funds.
And let’s be clear. Manager ownership is so much more than a symbolic gesture of faith in the product and empathy for the investor. Indeed, there’s empirical proof that such funds have tended to outperform those that have no manager investment, based on studies conducted by Morningstar, Capital Group and others.
Back in 2008, Morningstar’s Director of Fund Research, Russel Kinnel, set out to determine what percentage of managers nationwide owned a portion of their own funds. The results, as he described them, were “staggering”:
Looking at the data, the figures that jump off the page are those where no one invested a dime. At U.S. stock funds, 47 percent report no manager ownership. And it gets worse from there. Fully 61 percent of foreign-stock funds have no ownership, 66 percent of taxable bond funds have no ownership, 71 percent of balanced funds put up goose eggs, and 80 percent of muni funds lack ownership.
Eighty percent! Of muni funds! I think it’s worth repeating that my largest position is in our firm’s muni bond fund, which has delivered 20 straight years of positive growth. Out of 25,000 equity and bond funds, only 30—NEARX among them—have been able to achieve such a feat.
Granted, the Morningstar data is seven years old, but it’s “staggering” nonetheless. Since 2005—three years prior to the study—the Securities and Exchange Commission (SEC) has required investment firms to disclose manager ownership in their annual SAIs. Given this level of transparency, you’d think more firms would encourage their managers to put some skin in the game.
Because putting your own money on the line usually fosters a greater sense of urgency and commitment to performance.
Kinnel reiterated the benefits of manager investment in a January 2015 interview:
We looked at ownership levels from five years ago and then performance over the ensuing five years to test out whether you would have had improved results if you had chosen along the lines of manager ownership, and it looks like you would have.
Below you can watch Kinnel’s entire interview with Morningstar.
If you missed my conversation with star portfolio manager John Derrick earlier this week, be sure to watch the replay to learn how our NEARX fund has achieved 20 years of drama-free history during past stock market corrections and interest rate increases.
|One-Year||Five-Year||Ten-Year||Gross Expense Ratio||Gross Expense Ratio After Waivers|
|Near-Term Tax Free Fund||3.07%||2.64%||2.98%||1.21%||0.45%|
Expense ratio as stated in the most recent prospectus. The expense ratio after waivers is a contractual limit through December 31, 2015, for the Near-Term Tax Free Fund, on total fund operating expenses (exclusive of acquired fund fees and expenses, extraordinary expenses, taxes, brokerage commissions and interest). Performance data quoted above is historical. Past performance is no guarantee of future results. Results reflect the reinvestment of dividends and other earnings. For a portion of periods, the fund had expense limitations, without which returns would have been lower. Current performance may be higher or lower than the performance data quoted. The principal value and investment return of an investment will fluctuate so that your shares, when redeemed, may be worth more or less than their original cost. Performance does not include the effect of any direct fees described in the fund’s prospectus which, if applicable, would lower your total returns. Performance quoted for periods of one year or less is cumulative and not annualized. Obtain performance data current to the most recent month-end at www.usfunds.com or 1-800-US-FUNDS.
- The major market indices finished lower this week. The Dow Jones Industrial Average dropped 1.52 percent. The S&P 500 Stock Index fell 1.58 percent, while the Nasdaq Composite declined by 0.73 percent. The Russell 2000 small capitalization index fell 1.32 percent this week.
- The Hang Seng Composite fell 1.90 percent; Taiwan advanced 0.25 percent and the KOSPI gained 1.37 percent.
- The 10-year Treasury bond yield rose 25 basis points to 2.25 percent
Domestic Equity Market
The S&P 500 sold off this week but virtually the entire decline occurred on Friday. The highly anticipated nonfarm payrolls data was released Friday morning and was stronger than expected sending both stocks and bonds lower as it reinforces the idea of the Fed moving to raise interest rates as soon as mid-year. Interest rate sensitive areas of the market were generally the hardest hit.
- The financials sector was the best performer in a tough week. The Fed released the results of latest banking stress tests with all 31 banks passing, which is the first time that has happened. Banks also generally benefit from rising rates early in the cycle as net interest margins should improve. Bank of America, Comerica and MetLife were among the leaders.
- The consumer discretion sector was also a relative outperformer as cable and media companies outperformed. Discovery Communication, Time Warner and CBS were among the best performers.
- Gamestop was the best performer in the S&P 500 this week rising by 8.63 percent. The company announced it was increasing its dividend by 9 percent, which positively surprised the market.
- The utilities sector was the worst performing sector, falling by more than 4 percent. Interest rate sensitive areas of the market were hit particularly hard this week as bond yields moved sharply higher.
- The energy sector was also a poor performer this week even as oil prices were little changed for the week. After rallying from mid-January to mid-February, energy stocks have given back a good portion of those gains even though oil prices have stabilized this year.
- Joy Global was the worst performing company in the S&P 500 this week, falling 11.89 percent. The company reported earnings that disappointed investors and cut earnings estimates for the full year on slowing demand for mining construction equipment.
- Cyclicals outperformed in February as improving global growth prospects provide a lift and if China and Europe continue to improve the trend is likely to persist.
- A strong dollar continues to benefit domestic consumers, maintaining an advantage for certain U.S. focused retailers and consumer products.
- Retail sales data will be reported next week for February and could have an impact on the group. While many retailers have reported already, there remains a few to report next week including Staples, Urban Outfitters and Dollar General.
- Consumer sentiment indicators were mixed this week and it is a little surprising that the low oil price gasoline “tax cut” is not having a bigger impact on consumer spending patterns.
- An improving global economy and U.S. economic data that supports an improving job market may very well be enough to allow the Fed to raise rates as soon as June.
- Yield proxies have been hit hard in recent weeks and, if the Fed continues on its current path, they may not get any respite.
The Economy and Bond Market
U.S. Treasury bond yields moved sharply higher this week and the market reacted to the stronger-than-expected nonfarm payroll data that was released Friday morning. The unemployment rate fell to 5.5 percent in February, reinforcing the idea that the Federal Reserve could raise interest rates as soon as mid-year. Two-year Treasury yields rose to the highest level so far this year and nearing four-year highs.
- Nonfarm payrolls grew in February as data shows the U.S. economy added 295,000 jobs, continuing a recent run of relatively strong job gains.
- The eurozone composite purchasing managers’ index (PMI) data, which includes services and manufacturing, rose for the third straight month and indicates economic expansion.
- The HSBC China Manufacturing PMI also rose in February and broke back above the critical 50 level. Any reading above 50 indicates growth in manufacturing; anything below, contraction.
- The ISM manufacturing index here in the U.S. fell to 52.9 and while still in expansion territory, is the fourth monthly decline in a row after peaking in October.
- China set its 2015 GDP growth target at 7 percent, reflecting the “new normal” of slower growth in the country.
- A variety of U.S. economic data points disappointed this week. Factory orders, construction spending and auto sales all came in below expectations.
- European data continues to positively surprise and appears to be gaining some momentum.
- China inflation recently hit a five-year low. The central bank cut interest rates last weekend and more easing is likely.
- Yields in the U.S. remain the highest in the developed world and funds will likely continue to flow into U.S. fixed income.
- One theme from the recent earnings season was that the strong U.S. dollar has negatively impacted companies’ bottom line. This could continue to be the case for the first quarter, as the dollar was quite strong again this week.
- February retail sales will be released next week. If the data is strong, this would be another way the Federal Reserve can justify their stance of normalizing interest rates.
- With a global easing cycle underway, economic growth expectations have already started to improve making it an easier decision for the Fed to possibly raise rates.
For the week, spot gold closed at $1,165.66 down $47.56 per ounce, or 3.92 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, lost 11.57 percent. The U.S. Trade-Weighted Dollar Index surged 2.47 percent for the week.
|Mar-2||Europe CPI Core YoY||0.60%||0.60%||0.60%|
|Mar-2||U.S. ISM Manufacturing||55||52.9||53.5|
|Mar-4||U.S. ADP Employment Change||219K||212K||213K|
|Mar-5||ECB Main Refinancing Rate||0.05%||0.05%||0.05%|
|Mar-5||U.S. Initial Jobless Claims||295K||320K||313K|
|Mar-6||U.S. Change in Nonfarm Payrolls||235K||295K||257K|
|Mar-12||German CPI YoY||0.10%||—||0.10%|
|Mar-12||U.S. Initial Jobless Claims||305K||—||320K|
|Mar-13||U.S. PPI Final Demand YoY||0.00%||—||0.00%|
- Gold traders are bullish for a second week on the outlook for increased demand from Asia. The Shanghai Gold Exchange saw withdrawals of 412 metric tons as of February 27. Annualizing that would mean 2,472 metric tons for 2015, an increase of close to 18 percent 2,102 metric tons in 2014. Additionally, imports by India are expected to surge following the government’s decision to maintain current tax rates. The expectation had been for taxes on imports to drop, causing locals to hold off on purchases during February. This could cause purchases to jump to 100 metric tons in March from about 25 tons in February as jewelers and traders replenish stockpiles.
- BullionVault’s Gold Investor Index climbed in February at the fastest pace since April 2013. Furthermore, the gold gauge measuring the balance of buyers against sellers rose to 54.5 in February versus 50.5 in January.
- Perth Mint gold coin and minted bar sales rose to 31,981 ounces in February, an increase from January’s 23,174 ounces.
- Bullion erased its 2015 gains and fell the most in more than a year on Friday after a government report showed U.S. employers added more jobs than forecast in February. The unemployment rate dropped to the lowest in almost seven years. Holdings in exchange-traded funds backed by gold headed for the biggest weekly decline since November.
- March has historically been the worst month for bullion. According to data compiled by Bloomberg from the past four decades, bullion futures have dropped 1 percent on average in March. Prices have fallen 65 percent of the time, more than any other month.
- RBC is forecasting year-over-year production to decline by about 10 percent in 2018 and 2019 at Kinross Gold. They also see costs increasing 5 percent from 2015 to 2019. In other company news, Eldorado Gold was blocked from completing construction of a processing plant at its Skouries Mine in Greece.
- According to billionaire investor Thomas Kaplan, telling Indians not to buy gold is like asking Americans not to consume liquor. He said the metal has historically been a very good way to store wealth for India and also pointed out that China is “specifically and overtly” encouraging its people to buy gold. He went on further to say that when people tell him gold and silver are commodities, he counters saying the metals are currencies. This is because in a world of massive money printing, silver and gold can’t be debased. Thus, gold and silver are the only financial assets that you can own that do not represent someone else’s liability.
- In an attempt to rebrand itself as a mining-friendly jurisdiction, Ecuador is hoping that incentives and tax benefits will polish its tarnished image and attract $5 billion worth of investment over the next five years. The government believes that incentives passed in October will attract foreign miners to help develop the country’s gold and copper riches. They include 30-year investment contracts that promise tax stability and accelerated depreciation. Rafael Poveda, Ecuador’s Minister of Strategic Sectors, said the government has made the decision that mining constitutes a central axis in its development plans.
- The price of gold could be boosted by Akshaya Tritiya, the Indian holiday that is considered by Hindus as an auspicious day to buy precious metals. The holiday falls on April 21 this year. Additionally, the central bank of Mauritius announced it plans to invest heavily in gold as a refuge from volatility.
- The chart below from the University of Michigan’s sentiment survey shows over 60 percent of households were bullish on stocks in February. Survey results like these were last seen in July 2007, right before the last bull market took a nosedive. A modest position in gold could act as a diversifier against downside economic risks.
- MinEx Consulting published a research report showing that in the last decade junior explorers did a 30 percent better job than senior miners at finding deposits, both in measures of bang-for-the-buck as well as the number of discoveries made. According to their piece, the value discovered by juniors was $12.1 billion vs $7.9 billion for seniors for 2005 thru 2014.
- In the 1970s, even the best-performing, most credible central banks struggled to tame inflation. Today, even the best-performing, most credible central banks are finding it difficult to avoid deflation. Given that it was near impossible to avoid unwanted inflation back then, the question arises as to why it should be any easier to avoid deflation today. Taming deflation through monetary policy alone is likely to be a lot more difficult than taming inflation. This is because interest rates can rise infinitely, if necessary. However, they can only fall to zero, or to marginally negative levels, thanks to the existence of cash. With so few policymakers taking the threat of deflation seriously and with so many of them convinced that economic recovery is around the corner, the risk is that we could sink further into the deflationary mire thanks to weak monetary growth, high levels of debt and persistent deleveraging.
Energy and Natural Resources Market
- Construction materials stocks outperformed this week as the U.S. recovery remains strong and the rest of the world has started to catch up. The S&P Supercomposite Construction and Materials Index rose 1.4 percent this week.
- Clean energy stocks rose for the fifth straight week. Pacific Ethanol Inc. jumped 23.42 percent this week, while the NASDAQ Clean Edge U.S. Liquid Series Index rose 0.55 percent.
- Tankers were a relative outperformer this week as abundant oil supply stirs the need for storage. The Bloomberg Tanker Index rose 0.11 percent this week.
- Precious metals stocks retreated this week as investors anticipated strong U.S. nonfarm payroll data. The NYSE Arca Gold Miners Index fell 11.93 percent this week.
- Base metals stocks underperformed this week, breaking a six-week positive gain streak. The S&P/TSX Capped Diversified Metals and Mining Index fell 6.56 percent.
- Major integrated oil stocks fell this week alongside crude oil prices. The BI Global Integrated Oils Valuation Peers Index fell 4.67 percent this week.
- Louis Dreyfus Commodities has sent a $17 million shipment of U.S. ethanol to the Middle East, according to traders, and could be a sign of increasing demand overseas.
- In regards to merger and acquisition (M&A) activity, Exxon Mobile’s CEO Rex Tillerson stated that there is no limit in terms of what deals the company may be considering. It looks as though such a statement could provide an opportunity for Exxon’s target.
- The yield on the 10-year U.S. Treasury note spiked this week, a positive sign of global growth.
- According to Oppenheimer’s technical analysis, energy has been the best performing S&P 500 sector in the months of March and May since 1990. As you can see in the chart below, WTI crude oil has also experienced favorable seasonality for this time of year.
- The U.S. dollar made an 11-year high on Friday after strong nonfarm payroll data was released. The dollar continues to show strength and has yet to show any sign or reason to reverse its course.
- Economic growth throughout emerging markets remains in question. If the global economy remains sluggish, this could pose a threat for commodity demand moving forward in 2015.
- Indian stocks rallied this week as investors have become increasingly optimistic over Prime Minister Modi’s reform agenda. The S&P BSE SENSEX Index rose 0.30 percent this week.
- The Russian ruble saw its fifth straight weekly gain as tensions in eastern Ukraine ease and Brent crude oil continues to find support. The ruble rose 2.10 percent against the U.S. dollar this week.
- After depreciating by over 40 percent in the month of February, the Ukrainian hryvnia rebounded this week on speculation that the International Monetary Fund (IMF) will sign a multi-billion dollar rescue package for the struggling economy. The hryvnia rose 16.08 percent this week.
- Turkish stocks, as well as the country’s currency, fell this week as the conflict between the government and central bank regarding monetary policy worsened. The Borsa Istanbul 100 Index and the Turkish lira fell 4.56 percent and 4.89 percent, respectively.
- Brazilian equities declined this week along with the country’s currency as the central bank raised borrowing costs. The country is struggling to contain rising inflation and simultaneously boost economic growth. The Ibovespa Brasil Sao Paulo Stock Exchange Index and the real fell 3.11 percent and 6.39 percent, respectively.
- Greek stocks retreated this week after seeing positive gains in the month of February. The Athens Stock Exchange General Index closed down 3.43 percent this week.
- Comments from European Central Bank (ECB) president Mario Draghi regarding the initiation of the ECB’s bond purchasing program emphasized the stimulus that European growth, and implicitly global growth, should expect.
- India’s composite purchasing managers’ index (PMI) data came in at a robust 53.5, steadily rising since last September and signaling expected economic expansion.
- Poland implemented what it claims is the country’s last rate cut. The extra easing out of Poland should be positive both domestically and throughout Europe.
- Brazil’s economy is in rough shape, leading to continued downward revisions in growth forecasts from economists. This week legislators rejected a proposal from re-elected President Rousseff which sought to eliminate certain tax breaks in order to shore up the government’s fiscal problems. Brazil has been placed on a negative outlook from Moody’s Investors Service.
- Turkey seems unable to resolve the conflict between its central bank and government. The country’s political climate, combined with slower growth and higher unemployment, creates a serious risk to investors.
- Russian inflation rose in February at the fastest pace since the ruble crisis in 2002. The sharp increase in inflation inhibits the central bank’s ability to ease the burden of high borrowing costs facing domestic companies.
Leaders and Laggards
The tables show the weekly, monthly and quarterly performance statistics of major equity and commodity market benchmarks of our family of funds.
|S&P Basic Materials||316.08||-6.53||-2.02%|
|Hang Seng Composite Index||3,330.09||-64.63||-1.90%|
|Korean KOSPI Index||2,012.94||+27.14||+1.37%|
|S&P/TSX Canadian Gold Index||160.79||-21.22||-11.66%|
|Natural Gas Futures||2.84||+0.10||+3.69%|
|10-Yr Treasury Bond||2.25||+0.25||+12.59%|
|S&P Basic Materials||316.08||+9.39||+3.06%|
|Hang Seng Composite Index||3,330.09||-332.01||-14.83%|
|Korean KOSPI Index||2,012.94||+50.15||+2.56%|
|S&P/TSX Canadian Gold Index||160.79||-31.07||-16.19%|
|Natural Gas Futures||2.84||+0.17||+6.50%|
|10-Yr Treasury Bond||2.25||+0.49||+28.14%|
|S&P Basic Materials||316.08||+4.41||+1.41%|
|Hang Seng Composite Index||3,330.09||+28.19||+0.85%|
|Korean KOSPI Index||2,012.94||+26.32||+1.32%|
|S&P/TSX Canadian Gold Index||160.79||+14.54||+9.94%|
|Natural Gas Futures||2.84||-0.97||-25.43%|
|10-Yr Treasury Bond||2.25||-0.06||-2.69%|
Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.