Mutual Fund Industry
Your Fund Manager Probably Doesn't Own Shares of Your Fund.
A recent report from Morningstar alerted fund investors to a seemingly disturbing fact: almost half of mutual fund managers don't own shares of the funds they manage.
Each manager on a fund must disclose his or her investment, so there are multiple investment amounts for every fund with more than one manager. When looking at the data (encompassing approximately 6,000 funds), the figures that jump off the page are those where no one invested a dime. In U.S.-stock funds, 47% report no manager ownership...With the two exceptions I spelled out, I can't think of why anyone should invest in a fund that its own manager doesn't invest in."
This piece led to several articles, including this one, where reporters were equally outraged. After all, would you eat in a restaurant where the chef doesn't eat his own food?
As long-term critical observers of mutual fund industry goings on, we're not going to take the bait on this one. We don't really care either way if a fund manager has money in the funds they manage.
Mutual fund managers at top fund companies are different than many individual fund investors. They are often very rich. Many of them make seven or eight figure incomes; many own stakes in their fund companies worth millions or even billions of dollars.
There are more investment opportunities open to rich people than mutual funds, including venture capital, hedge funds, and private equity. Most actively managed mutual funds are not ideal investments for rich folk in the highest tax bracket because funds often distribute other investors capital gains to whomever happens to own the fund at a certain time. Wealthy people don't even like paying their own taxes much less yours. Top fund managers can own stakes in the fund company itself. Buying their own fund would only increase there exposure because if the funds slip, the fund company stock they own could also drop. In addition, for the same reason we recommend keeping you allocation to company stock in a 401(k) down, fund managers may not want the additional risk of owning their fund because if they get fired for bad performance, they would have also lost a good chunk of their retirement money in the fund with the bad performance.
Most mutual funds are a retail product, meaning they are generally designed for people with net worths between $25,000 and maybe $1 million. The fee structures for many retail funds - notably load funds - are relatively high, and the more money invested the more in fees an investor pays. The benefit of diversification and active management are often worthwhile trade-offs for average investors given the difficulty of diversifying a portfolio globally with a small portfolio. Many of these expert money managers would do better owning the stocks directly. Let's not forget they are fund managers and choose their own stocks for a living.
We'd guess a lot of mutual fund managers do invest in high minimum/low fee institutional class mutual funds, ETFs, index funds, and even closed-end funds. In fact we've been watching famed bond manager Bill Gross buying shares in some PIMCO closed-end funds recently. If you have $10 to $100 million dollars and an annual income of over $1 million, you should do the same. For everybody else, keep an eye on the fees of your funds and do your best with a relatively small portfolio to keep the total portfolio expense ratio down and avoid load funds.
Another Prediction For The Death Of Funds
The Wall Street Journal (yet again) discusses the probability of the slow end to the twelve trillion dollar mutual fund industry:
Mutual funds have been resilient despite rivalry from other investment options like exchange-traded funds, hedge funds and separately managed accounts, but now some investors are having their doubts.
A recent survey by consultants Cogent Research in Cambridge, Mass., suggests that many affluent investors have great concerns about the fund business. Among other things, the survey found that shareholders believe fund companies don't have their best interests at heart, citing such issues as excessive trading, lack of transparency in fees and a failure by the industry to clearly articulate tax and risk issues. The survey was commissioned by Barclays Global Investors, a giant in exchange-traded funds, or ETFs, and a unit of Barclays PLC."
We blogged about this study a few days ago (29% of People Trust the Fund Industry...), and still don't think it signals a death knell for mutual funds. Funds still offer key benefits, especially for the legions of 401(k) investors:
1) Low Minimums - investors can efficiency get active or passive management into just about any market in the world with as little as $1,000.
2) Cheap to Buy and Sell - investors can add a few bucks a week without paying commissions (which they can't do with stocks or ETFs).
3) Built In Sales Loads - O.K. this isn't really a benefit to buyers so much as sellers, but so long as funds can obfuscate such commissions, ETFs will never take over the world. There is no way to manage a client account easier and more profitably (to the broker) with more fee obscuring than with load-bearing mutual funds.
4) Fund Performance - everybody whines about how crummy fund performance is, but if you could easily compare fund performance to individual accounts at say E*Trade or even many broker managed accounts in stocks, the fund industry wouldn't look to shabby.
Other criticisms of funds noted in this article barely hold water. One source notes that funds get paid to gather assets, not perform well - and people are wising up to this fact. While nobody complains about the evils of giant funds more than we do, the reality is funds don't get big or stay big without decent performance. And what's the alternative? Performance based fees, like those most hedge funds levy, have their own drawbacks: a 20% cut of profits can be an incentive for hedge fund managers to take big risks with investors' money.
Leverage - Some Funds Are Hurtin' For Certain Too
While Buffett warns against the use of leverage, Wall Street and the banking system decided that leveraging up into high return, low risk assets (like real estate...) was a great idea.
Mutual funds that use leverage - primarily closed end funds but also newfangled 130/30 funds, had a crummy 2008.
In recent years, more mutual funds have used borrowed money to juice returns and lure investors. Now, they are discovering the downside of leverage, and some are cutting back.
Early last year, Wall Street was heavily promoting several new types of funds that rely on borrowing money. These include so-called 130/30 funds that aim to amplify market returns by betting against some stocks, as well as "leveraged index" funds, which promise to double the return of a market index or double its inverse.
At the same time, closed-end funds, many of which have used leverage for decades, were growing rapidly until 2007.
While borrowing money can improve returns in good times, it also widens losses in bad times, and that is what happened in 2008. Some of these funds ended the year with even greater losses than the market as a whole. For instance, of the 15 mutual funds that apply the 130/30 strategy for U.S. stocks, only a third beat the Standard & Poor's 500-stock index in 2008, according to Morningstar Inc. Some of the laggards fell behind the index by five percentage points.
We remain amused by the mutual fund industrial complex's ability to generate new ideas to sell shortly before the market takes a long trip south.
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