Should fund managers invest in their own funds?

Reasons to invest
Why should a portfolio manager invest in the fund he or she manages?  The key argument is to align interests – you would reasonably expect a manager to care deeply about how a fund is run if a material amount of their own money is committed to it.  It is greater than the alignment from a performance fee or staff bonus – the portfolio manager has exactly the same experience as investors. 

When a portfolio manager’s personal funds are at stake it is a sign that they believe in the investment strategy.  But not everyone agrees.

Reasons not to invest
There are several reasons given why it may be a bad idea for fund managers to invest in their own funds.  These include:

• Managers are already aligned: It is likely the manager’s personal interests are already aligned with investors.  There may be a bonus for beating the market, and the threat of job loss for under-performing….  Isn’t that enough alignment?
• Managers may skew to their own risk profile: If a manager has too much invested in a fund, then they may start managing it to suit their own personal preferences and risk profile.  It may make them fearful of taking on risk.  This argument is valid if a manger were to commit too much of their personal wealth to a fund or if they own a very large portion of the fund (in which case they may feel it is their own personal fund).
• Using personal investment brings in emotion and is a bad way to align: You may want the portfolio manager to stay dispassionate and not get emotionally connected with the fund.  Could that lead to better decision making?

What the evidence tells us
A 2008 paper published by Russel Kinnel (Director of Fund Research at Morningstar) looked at investment in US mutual funds by the individual portfolio manager responsible for the fund.  The research was particularly interesting given that US managers had only recently been required to disclose their personal holding.  The research was later repeated in 2011.