More than half of all portfolio managers tracked by Morningstar didn't invest in their own funds during the past five years. "How are customers supposed to trust someone who appears to not even trust himself?" asks Dan Carroll, founder of KaChing, a site where professional investors share everything about their portfolios -- including how much of their own money they've put in them -- in hopes that others will pay to mimic their trades. The ideas underpinning the Palo Alto-based company should be copied by the mutual-fund industry. Here are six to start.
1. Reform the Ratings
Rather than focus on past performance -- which, as the commercials always say, doesn't indicate future success -- KaChing employs an algorithm to calculate users' investing IQs, accounting for research quality, ability to stick to strategy, and at least a year's worth of returns. Those who score above 140 are labeled "geniuses."
2. Let Information Fly
Because Carroll believes that "information wants to be free," anyone can view investors' profiles, and receive email alerts when they trade. Fees only apply to "mirroring," or automatically allocating money the same way a genius does, which is made possible through a partnership with Interactive Brokers.
3. Cut Frivolous Fees
On average, users pay a 1.25% annual fee to "mirror" genius trades (minimum investment: $3,000) -- less than many non-index mutual funds, which charge for marketing and advertising expenses. KaChing pockets a quarter of that money; the rest goes to the genius as an incentive.
4. Embrace Transparency
By flipping through a user's investment history, performance analytics, and stock portfolio, anyone can evaluate trading habits in real time. "There's no room for window dressing," says CEO Andy Rachleff, citing managers who mask underperformance by buying hot stocks before issuing a quarterly report.
5. Talk to Clients
"If you called Fidelity to speak with the person who runs your mutual fund," says Carroll, "you'd probably get laughed at." On KaChing, however, the Facebook Wall-style message board allows clients to communicate directly and publicly with their money managers.
6. Share Insights
Geniuses are encouraged to explain every trade they make, and include stats and articles that support their thinking. "That way," Carroll says, "you know they're not farming out research, or picking stocks from CNBC." If clients are wary of the logic, they may cash out at no additional cost.