Fund managers can make a killing managing other people's money. In hedge funds and private equity, the baseline fee is 2% of assets annually, plus 20% of performance.

Sometimes the fees are worth it. Sometimes they aren't.

One way to get a quick look is to see if fund managers are investing their own capital with you. Does your manager believe in his or her fund like he wants you to believe in it?


Which BDCs are owned by insiders?
Business development companies like are known for high costs of ownership. Ares Capital and Prospect Capital charge an annual management fee plus performance fees. Main Street Capital and Triangle Capital simply pay employees a salary and award some bonuses in cash and stock options.

I wanted to know which BDC has the greatest insider ownership. If they believe in the fund, the people running it would have their money on the line, too. As a shareholder, you want management to invest as if it is their own money at stake. If managers own a significant amount of the stock, it's in their interest to make good investments on behalf of all shareholders.

So here's the breakdown:

BDC Name

Insider Ownership in Dollars

As a Percentage of Market Cap

Ares Capital

$43.2 million

0.8%

Prospect Capital

$44.6 million

1.4%

Main Street Capital

$98.7 million

8.2%

Triangle Capital

$30.3 million

3.8%

Source: S&P Capital IQ.

What's all this mean?
We have to put it in context. It's obvious at first glance that of the BDCs, Main Street Capital has the highest insider ownership and the highest total ownership by dollars. Interestingly, Main Street Capital also has the portfolio with the highest credit quality metrics of the BDCs and the lowest cost structure of any BDC in the table. Triangle Capital also has a very shareholder-friendly formation, and insider ownership of its shares should give investors some confidence that management has its money at risk, too.

The laggard by market cap, Ares Capital, still has a lot of insider ownership by total dollars. And its track record and recent quarter suggest it's anything but poorly managed. Prospect Capital's managers have purportedly never sold a single share, according to its presentations.

However, there is one important level of detail missing with Prospect Capital and Ares Capital -- we don't know how the holdings stack up to employee salaries. As externally managed BDCs, management salaries aren't disclosed to the public. In both cases, insider ownership amounts to less than half of each company's base management fee of 1.5% at Ares Capital and 2% at Prospect Capital. That doesn't even begin to include the incentive fee of 20% of gains in the portfolio.

I make this point not to dismiss management at either of these BDCs, but to note that stock holdings are relative. A million bucks in stock is a lot to someone who makes $20,000 per year, but not someone who earns $3 million. If we don't know how much these managers earn, we don't know what a few million dollars really means to them. For smaller, internally managed BDCs like Triangle Capital and Main Street Capital, we know insiders' stock holdings are large enough that a gain or loss could wipe away years of salaries.

The Foolish takeaway
Agency costs are a real problem. Managers who are heavily invested in their own companies and their decisions have more to lose by making poor decisions for shareholders. All else equal, you want managers to treat your money as if it is their own. Keeping tabs on a company's management ownership is a great way to see if your interests are truly aligned.

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The article Do Your Investment Managers Eat Their Own Cooking? originally appeared on Fool.com.

Fool contributor Jordan Wathen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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