Why Stewardship Matters

Good stewards put unitholder’s interests first and provide a better investor experience over the long haul

David O'Leary 10 October, 2012 | 8:00AM

Ask yourself this: Why did I purchase the last mutual fund investment I bought?

You wouldn’t be alone if your answer had a lot to do with how well the fund had performed recently. It’s a well documented phenomenon that investors have a bad habit of chasing short term performance. If you’re an astute investor your purchase might have been motivated by the fund’s longer term performance, the quality of the people running the fund, the process they use to select investments, or the fund’s price tag.

Few people however are likely to have said that a favourable assessment of the fund company’s stewardship was critical to their decision. This is unfortunate because research we’ve done demonstrates that good stewards produce higher returns and provide a better overall experience for investors.

Stewardship analysis boils down to conducting a character assessment of a company. Since many mutual funds are meant to be long term investments you want to partner with a firm that will treat you well long after you’ve signed the original purchase documents.

There isn’t one right way to go about evaluating a firm’s stewardship. But at Morningstar we break it down into four components: Corporate Culture, Financial Incentives, Fees, and Regulatory History. To evaluate these components we conduct extensive due diligence. We scour regulatory filings and any other publicly available information and spend a lot of time interviewing a wide range of personnel (CEO’s, CIO’s, portfolio managers, marketing, legal and compliance, etc). While you may not have the time or resources to conduct a detailed analysis you can begin by putting questions about stewardship to the fund companies or advisor you deal with.

Corporate Culture

Understanding a firm’s corporate culture can tell you a lot about a firm’s values and priorities, what type of people it attracts, and what motivates them. In turn this can tell you a lot about whether it is likely to have your best interests at heart.

To gage a firm’s culture we ask a lot of questions. Is the fund company focused on investing or on gathering assets? Is it straightforward with investors and does it offer clear, pertinent disclosure and responsible marketing? Can the firm attract and retain talented investors? Does the firm take risk management seriously?

For instance, to help answer the first question we’ll look at the firm’s approach to product creation. Some firms will sell any “flavor of the month” product an investor is willing to buy. These products typically get launched at market peaks when investor demand is at a fever pitch. Investors pour money into these products at inflated valuations only to suffer huge losses when the market eventually crashes.

A firm that launched an internet fund in 1999, a global real estate fund in 2007, and a gold fund in 2011 probably adheres to the “sell anything to anyone” philosophy. Of course, it would be unfair to judge a firm’s corporate culture based on a single ill-timed fund launch. But a pattern of this behavior is indicative of a firm focused more on salesmanship than stewardship.

We prefer firms that are more selective about the products they are willing to offer. These firms only offer those funds they believe represent attractive long term investments and are willing to forgo the sales opportunities associated with catering to the whims of investors. In finance, as in life, most of us need someone who isn’t afraid to tell us when we’re wrong.

Financial Incentives

Here we look at how the firm’s personnel are financially motivated and whether their financial interests are aligned with those of fund investors. There are two specific factors we evaluate here: compensation and co-investment.

We prefer firms that pay their managers based on how well their funds do in the long run. Meanwhile firms lose points if they tie a manager’s pay to short term performance or, even worse, fund sales since this can incentivize a manager to spend their time going on sales calls instead of managing the portfolio.

We also ask firms whether their fund managers actually invest in the same funds they pitch to the public. Unfortunately, the only country in the world to require this disclosure is the United States. Everywhere else, fund companies do not have to provide this information. 

So we ask firms to voluntarily disclose this information. Some are willing to while others are not. But you have to wonder about a firm that clams up when this subject arises. After all, it’s not very comforting to dine at a restaurant where the chef won’t eat his own cooking.


At the risk of stating the obvious, we prefer firms that generally offer attractively priced funds. There are numerous studies that argue fees are the single best predictor of future fund performance. We measure on average whether a firm’s funds are expensive or cheap relative to their peers. But we don’t blindly award low costs. The firm must offer a good value proposition. If it is cutting costs at the expense of quality risk management or proper transparency and communications, that won’t benefit investors.

Regulatory History

Here we examine any regulatory problems at the fund company in recent years. It goes without saying that we look to avoid firms that are regularly bumping up against the law. It’s worth spending some time researching media coverage of the firm or any possible news from the regulators about problems at the firm you’re thinking of investing with.

To be sure, the analysis above is very subjective and consequently can be quite difficult to measure. But that doesn’t meant it isn’t valuable. Both investors and the fund industry can benefit from focusing the investment conversation on stewardship. It will help deter skittish investors from the fund hopping that occurs when they chase last year’s winners. And it can help the industry identify best practices and encourage stakeholders to adopt policies that benefit their most important constituent, you.

About Author David O'Leary

David O'Leary  is Director of Fund Research for Morningstar South Africa