We have been looking at the tool we most often use for retirement, be it in your 401k or in an Individual Retirement Account (IRA): the mutual fund. We have explored fees and performance earlier this month and found that there are more elements for confusion than there are clarity. Now we delve into the most difficult comparison of all: the mutual fund manager.
The mutual fund manager may any one of the following: a man, a woman, a team, or a computer. They may use an algorithm, a method or simply rely on their vast years of experience. Whatever they may be, they are held responsible for the invested dollars you have channeled into their charge. They have a fiduciary responsibility, as all members of the securities industry do, to do what is best for the least investor.
But many are also beholden to a higher power, the shareholder who owns the company that owns the mutual fund. It is often this conflict that gets in the way of the fund manager from doing what is best for their investors. According to Dan Jamieson writing for Investment News, a magazine focused on the adviser industry the problem is not fees or performance, although they play a role. It is whether or not the fund manager agrees with what they are doing to invest in their own fund.
According to Jamieson “Morningstar also found that in 51% of the 4,383 funds it has tracked for manager ownership levels over the past five years, fund managers owned no stake at all. Having a stake in a mutual fund means that managers have their interests “truly aligned with shareholders’,” said Karen Dolan, director of fund analysis at Morningstar.”
On the surface this appears to be troubling. According to the report, only 413 of the fund managers in this cross section of funds, many of which contain index funds, target date funds, funds with offshore management, funds that invest in tax-free municipal bonds that are invested in another state and fixed income funds and, it should be noted encompass only about half of the available funds, have $1 million or more of their own dollars invested alongside their shareholders.
Once again, this tells only part of the story. The rest is left to speculation. So we will speculate. Suppose you were working for a firm whose products were used by consumers. But the actual product is more of a store front, a collection of other products made by other manufacturers. Suppose we use the example of a grocer, which like a mutual fund manager collects a fees for representing their owners and the the products s/he sells to the customers who shop there.
Like the fund manager, the grocer is merely a conduit, a middle man. The fund manager/grocer is actually employed by someone other than the products s/he sells and in all likelihood, they have their own retirement plans. If they were smart investors in those plans, they would be diversified. But I would be willing to wager that every fund manager holds an unadvisedly large amount of their own company’s stock. This is more than company’s fault than the fund managers and like the grocer, they go where the match is.
So why would they invest in their own products in addition to what they put away in their 401k plans? Because they consider themselves investors. Most mutual fund investors do not consider themselves savvy enough to carry forth into the world of investing on their own. They choose funds because owning individual stocks is not as easy as it sounds. But fund managers may seem as though they are above the fray, able to pick amongst the best stocks without diversifying the way fund manager’s expect.
Should fund managers invest in their own funds? Some believe they should and because they don’t want their fund managers to show up on the Morningstar list as having no invested interest, they have begun paying bonuses in fund shares. Does side-by-side alignment help fund performance? It is possible that they fund might do better but the jury is still out on that one.
While Jamieson adds, “Some managers may invest in their strategies, she [Dolan] noted, but through a separate-account platform at lower cost than the public fund” he believes that this sort of investing should be a shared experience.
Almost as a caveat, “Furthermore, some funds may not be available outside of retirement plans, Ms. Dolan said. At the same time, some managers don’t want to be pigeonholed into a particular style. Others might hesitate to invest because they know they may not be around very long, or they invest through a separately managed account platform at a lower cost than the public fund.”
So how do we compare how they do? While people who subscribe to the belief the index funds beat actively managed funds more times than not, as we said previously, not all actively managed funds hold the same number of stocks as the index. The question should really be: how efficient are they?
Fund managers need to have a frim grasp on the cost of running the fund. They should keep taxable events to aminimum, turnover costs as low as possible and have the ability to reign in outsized research costs. They should encourage theior employers (not you the shareholder as many would have you believe) to lower expenses as much as is physically possible in the hope that this will attract more investors who pay less, not a few who pay more.
And lastly, to act unlike a human. We do not what mutual fund managers falling back on the same foibles that the rest of us possess. They should be cold-hearted and analytical, hard-nosed and calculated. They should be able to forecast and predict with amazing accuracy. They should be everything we are not.
In they end, they are just like us. They want to keep their jobs and please the investor who has put their money in their charge. You are the customer. You can always walk.
Paul Petillo is the Managing Editor of Target2025.com
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