It has been reported in the media that Kotak Mahindra Asset Management Company (AMC) has ruled that its employees who wish to invest in mutual funds, shall henceforth do so only in the AMC’s funds. The reports also suggest that employees will be penalized if they make fresh investments in funds from other AMCs after the policy comes into place.
The rationale behind the move is to introduce the concept of ‘skin in the game’. The concept is far more common in the West, than in India. For instance since 2005, the U.S. Securities and Exchange Commission has required AMCS to annually disclose how much portfolio managers invested in the funds they run.
To clarify, Kotak Mahindra AMC is not the first Indian AMC to institute a ‘skin in the game’ policy. While some AMCs pay (a part of) bonuses to their investment teams in the form of mutual fund units, others pledge that their top brass invest in funds from the AMC. What differentiates Kotak Mahindra AMC’s guideline is that perhaps for the first time, employees across the board who wish to invest in mutual funds, have been told to compulsorily do so, in the AMC’s funds.
Why ‘skin in the game’ matters
From an investor’s perspective, is Kotak Mahindra AMC’s guideline necessarily a positive one? I don’t think so.
To clarify, I have been a propagator of portfolio managers eating their cooking i.e. investing in funds they run for a while now; also, I believe there is a case for disclosing managers’ investments in funds they run. To understand why I am not convinced of the guideline in question, let’s delve further into the ‘skin in the game’ concept.
At its core, portfolio managers investing in mutual funds they run is all about inspiring confidence in investors. Portfolio managers who invest alongside their investors show a conviction in their investment approach and a confidence in their investment acumen. It’s a classic example of putting one’s money where the mouth is.
Coercion versus free will
The trouble with Kotak Mahindra AMC’s policy is that there is an element of coercion. Employees (including portfolio managers and analysts) who wish to invest in mutual funds, will invest in funds from the AMC because they are being forced to do so, not because they want to. For an act to inspire confidence, it must be voluntary and not compulsory. Even if managers claim that they have invested in funds from the AMC voluntarily, that argument is unlikely to find many takers, given the existence of a policy which dictates such investments.
What AMCs must do
If Indian AMCs are serious about building investor confidence, they must adopt the ‘skin in the game’ concept in letter and spirit. Apart from voluntary investments by portfolio managers, AMCs can explore avenues such as offering a part of the compensation in locked-in units from the AMC’s funds, or periodically disclose investments made by managers in funds they run.
Most importantly, AMCs must appreciate the importance of free will for ‘skin in the game’ to have the desired effect.
