One Way to Ensure High Returns

According to a study recently published in The Journal of Financial Economics, there is a direct correlation between the amount of money a mutual fund manager has invested in his fund and its performance.

No huge surprise there, particularly if you've spent any time reading about the importance of "eating your own cooking."

But wait, it gets better
The study cites that the amount a manager invests in his fund is the most accurate indicator of how well the fund will perform over time.

In fact, high managerial ownership leads to the other factors smart investors should seek out in mutual funds: no loads, long managerial tenure, and a strong track record.

Quantifying this effect, the authors noted that for every additional basis point of overall managerial ownership of a fund, its performance tends to be 3 basis points higher. So given that the average fund manager owns 0.04% of the assets he manages, if a manager owns 0.05% of the fund's assets, the expected return for the fund will be 0.03% higher than the average fund.

Put simply: The more a manager has on the line, the more likely he is to generate above-average returns for every shareholder.

How much do your fund managers trust themselves?
As of March 2005, mutual funds managers are required by the SEC to declare how large their stake is. You can find it in the fund's "Statement of Additional Information," which is most easily accessible through the fund's website. For smaller funds, it may require a bit more digging.

Though the monetized figures are generally not specific, they still provide you with a good way to analyze a fund.

Consider:

Oakmark Select I (OAKLX)

Goldman Sachs Capital Growth A (GSCGX)

Managerial ownership

Bill Nygren: over $1,000,000

Henry Berghoef: over $1,000,000

Steven Barry: $100,001-$500,000

Gregory Ekizian: $100,001-$500,000

David Shell: $100,001-$500,000

Data from each company's Statement of Additional Information.

Compared to the folks at Oakmark, the people at Goldman Sachs have a puny amount invested in their own fund. What's more, model money manager Bill Nygren confesses that he has every dime of his own money invested entirely in Oakmark funds -- so you can bet his ownership level is well over $1 million.

Put theory into practice
If the study above holds, Oakmark Select should be the better fund ... and it is:

Oakmark Select I

Goldman Sachs Capital Growth A

Front load:

None

5.50%

Expense ratio:

0.99%

1.40%

Managerial tenure:

11 years

10.8 years

Top 5 holdings:

Washington Mutual
Yum! Brands (NYSE:YUM)
McDonald's (NYSE:MCD)
H&R Block (NYSE:HRB)
Discovery Holding

Google (NASDAQ:GOOG)
Cisco Systems (NASDAQ:CSCO)
Suncor Energy
(NYSE:SU)
Microsoft
(NASDAQ:MSFT)
Baker Hughes

10-year annualized performance

11.6%

5.2%

Data from Morningstar

As you can see, Oakmark is both the more shareholder-friendly fund (demonstrated by its far lower fees) and the more successful performer.

Even if you're more inclined to trade stocks, you may need mutual funds in your 401(k) account or as a diversification strategy. If you need some fund ideas, or would like some more tips on how to research the best funds for your money, the Fool's Champion Funds newsletter service can help you out.

Check it out risk-free for a month -- there's no obligation to subscribe.

Fool analyst Adam J. Wiederman owns no shares in the securities or funds mentioned above. Washington Mutual is an Income Investor recommendation. Microsoft is an Inside Value recommendation. The Fool's disclosure policy ensures high returns.


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