If you were to make broad generalizations about CEOs based on their portraits in annual reports, you'd assume they were all wise titans of business who spend most of their time with their arms crossed, peering into the distance.
You might also assume they have a good sense of the value of their business, and whether it is underpriced. That's not always the case, in part because CEOs tend to do fairly well whether or not their company's stock does well. But you can get a good sense of how well a mutual fund fares by the amount its manager owns.
The old adage among stock-pickers is that executives have many reasons to sell their company's stock — college tuition, taxes, that starter castle in the mountains — but only one reason to buy. And that's generally true: Most executives get plenty of stock as part of their overall compensation. Buying more must mean they are bullish on the stocks, and, given their insider position, they must know more than most people about the company's prospects.
All of this is true, but there's a hitch: They have to be savvy buyers of their own stock. And CEOs, even armed with inside information, often have the same distressing bell curve of ability that the general population has.
Let's consider General Electric (GE), the venerable industrial company that threw a rod this year as former CEO
Jeff Immelt departed and his successor, John Flannery, took over, swiftly slashing the company's
dividend in half as part of a restructuring bid. The stock has fallen 40% this year — and that's including reinvested dividends.
Mr. Immelt bought $1.5 million of GE stock for an average price of $29.24 in 2016, according to
insiderscore.com, which keeps track of legal insider buying and selling. By that point, his total purchases of GE stock that year totaled $5 billion, at an average price of $30.04 per share. The stock traded at $17.91 Tuesday.
Interestingly, Mr. Flannery has purchased GE stock on the open market just twice in recent memory. He picked up $2.7 million of GE stock in August at an average price per share of $25.56, and bought $1.1 million on Nov. 15, 2017, at $18.27 a share. His cumulative loss is 22.1%.
GE — the corporation — also has been making ill-timed purchases, snapping up nearly $30 billion of stock at an average price of $28.86 a share at an overall -38% return since the program began in April 2015.
Just because GE seems to have a poor sense of timing doesn't mean you shouldn't pay attention to insider trading. It just means you have to be careful about how you interpret it. Some insiders — and companies — are good at buying and selling their own stock. Others aren't.
The same is probably true for mutual fund managers with large stakes in their own funds. A study by the
American Funds recently found that high management ownership also has meaningful predictive value for actively managed funds. But high ownership, in and of itself, doesn't necessarily portend above-average performance.
For example, the manager of the Osterweis fund (OSTFX), John Osterweis, has more than $1 million in the $205 million fund, according to Morningstar Inc. The fund has consistently lagged in the small-blend category the past 15 years. Similarly, both Ronald and Jeffrey Muhlenkamp have move than $1 million in the Muhlenkamp Fund (MUHLX), which also has lagged its Morningstar category the past 15 years.
One reason may be that both funds have above-average expense ratios. The American Funds' study maintained that high ownership plus low expenses tended to indicate superior performance over time. The study found that U.S. large-company stock funds with combined low expenses and high management investment beat their benchmarks 86% of the time over the past decade, versus 23% of the time for the average equity fund.
"It makes sense that a manager will put money to work where it's the best idea for any investor, including themselves," said
Todd Rosenbluth, senior director of ETF and mutual fund research at CFRA. "But the big driver is the expense ratio. Cheaper funds have a better chance in up and down markets."
Just as CEOs may have blind spots when they view their own company, money managers may have blind spots when they view their own ability to beat their benchmarks over the long term. (They may also be victims of the fact that not all investing techniques work all the time.) In either case, knowing who is buying a stock or a fund is important — but it's just one arrow in the investment quiver.
