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For financial professionals on Wall Street, managing other people's money is considered the pinnacle of a career. But if you're an investor who's interested in tracking down the best stocks you can find, you don't just want to follow the stock picks of someone who takes care of other people. You want to buy stocks that top money managers believe in enough to put their own money on the line.
The Buffett effect
Many consider Warren Buffett to be the best investor ever. But just like anyone else, when he started, no one knew who he was. One way he built confidence early in his investing career was by putting his own money at risk beside his investors. Even now, Buffett takes only a relative pittance in salary to run Berkshire Hathaway (NYSE: BRK-B ) ; the rise or fall of Berkshire's share price has a much more dramatic impact on his net worth than the $100,000 in pay he pulls in annually. Because of that, investors know that Buffett's financial interests are aligned directly with shareholders, and it gives them confidence that he wants the company to perform just as much as they do.
Recently, Morningstar took a look at whether mutual funds whose managers invested substantial amounts of money in them performed better than funds whose managers didn't put their own money at risk. Most shareholders would probably want funds with big manager participation to be rewarded, and the study confirmed that hypothesis. Overall, stock funds whose managers had at least $1 million invested had results that were 12 percentile points better than the median. Those funds also earned an average of 3.5 stars on Morningstar's rating scale, as compared with less than 3 stars on average among funds whose managers invested nothing in their funds.
Looking beyond mutual funds
Morningstar focused on traditional mutual funds because that's its primary area of expertise. But because filings don't require managers to be more specific about how much of any given fund they hold, it's impossible to get the same level of confidence that you get with Warren Buffett's multibillion-dollar stake in Berkshire.
Fortunately, you can find evidence of leadership's commitment to particular stocks. The easiest way is to find CEOs with significant stock holdings that didn't come solely from incentives like stock option plans. That includes not only well-known owner-managers such Jeff Bezos of Amazon.com (Nasdaq: AMZN ) and Oracle's (Nasdaq: ORCL ) Larry Ellison, but also more obscure companies such as Airgas (NYSE: ARG ) , where CEO Peter McCausland holds a 7% stake.
But if you prefer to work with money managers who allocate capital across more than one stock, then the obvious choice is to track investors who use public companies as clearinghouses for bigger investments. Berkshire is the obvious example, but several others -- including Biglari Holdings (NYSE: BH ) , Markel (NYSE: MKL ) , and Leucadia National (NYSE: LUK ) -- all disclose many of their stock positions on SEC filings. If you like these companies' performance -- and many of them have put up big numbers recently -- then looking at the stocks they own may give you some ideas about where to put your own money.
Where manager stakes aren't an issue
On the other hand, there are some situations where you don't need a managers with big ownership positions to have confidence in a fund. The most obvious example is an index fund. As long as the fund follows the strategy dictated by the index, you can count on the same returns, regardless of whether the fund's managers invest in the fund. In fact, taking an objective, unbiased view of the fund might actually be a positive for an index fund, since it would make it less likely that managers might deviate from the fund's objective for their own personal gain.
For active funds, though, it's generally good to have someone with a vested interest in seeing your shares increase in value. Whether it's buying stock in companies where insiders own a substantial number of shares or investing with funds whose managers put their hard-earned cash alongside yours, finding shared incentives among the people running the show can reveal some great places to find great stocks.
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