MARKETWATCH
This story explains why shareholders take all the risk, while mutual fund managers never lose, and why mutual fund "active management" is not active at all.
As this article shows, the biggest abusers are American Funds and Fidelity. American is the darling of financial advisers since it has many share classes specifically designed to appeal to all financial professionals who can get paid their large fees and commission trails in any way they want. As this Web site continuously points out, these fee deals and under-the-table commissions are not directly explained to shareholders. This article also notes that Vanguard is a co-op (a fact not widely known), so its shareholders benefit directly from cost containment.
It is also interesting to note that Morningstar analyzed the largest funds and their fee revenues. What should be asked is what percentage of shareholders this large fund group represents. This number is important since the Investment Company Institute insists that fees are declining, but that figure includes all funds, not just the largest.
Dec. 23, 2009, 2:19 p.m. EST
Losing mutual funds still enjoy big paydays
Despite 2008 decline, some fund giants garnered more than $300 million in fees
By Sam Mamudi, MarketWatch
NEW YORK (MarketWatch) -- Many mutual-fund investors suffered heavy losses in 2008, but managers of some of the largest stock funds -- including ones that fell roughly 40% in 2008 -- gathered hundreds of millions of dollars in fees during that time.
Five stock funds -- three from American Funds and two from Fidelity Investments -- that individually lost more than 37% in 2008 each collected management fees of more than $300 million in their latest fiscal years.
The results, calculated by investment researcher Morningstar Inc., illustrate just how profitable the mutual-fund industry is for large fund managers in particular. At a time when their funds were suffering enormous full-year losses, they were still enjoying large paydays because mutual funds typically make money based on total assets rather than performance.
"[The results] argue that aligning end performance for fund shareholders with fees is important," said Karen Dolan, director of fund analysis at Morningstar, who conducted the study. "We've long been advocates of performance-based fees."
The five funds were: American Funds Growth Fund of America (FUND:AGTHX) , which was down 39.1% in 2008, but gathered management fees of $351.2 million in the 12 months through August; American Funds Capital World Growth & Income Fund (FUND:CWGIX) , which was down 38.4% in 2008 and collected $375 million in management fees for the year through November 2008; American Funds EuroPacific Growth Fund (FUND:AEPGX) , which was down 40.5% last year and had management fees of $381.6 million in the year through March; Fidelity Contrafund (FUND:FCNTX) , down 37.2% in 2008 with management fees of $348.6 million in the fiscal year ended December 2008, and Fidelity Diversified International Fund (FUND:FDIVX) , down 45.2% last year, pocketing management fees of $348.1 million in the 12 months through October 2008.
In addition to the management fees, the Fidelity funds charged performance adjustment fees, which Dolan said are based on performance versus their benchmark and not absolute returns, and typically for periods longer than a year. Contrafund's performance fee charge was $125.4 million, while Fidelity Diversified International Fund charged $34 million.
Fidelity and American Funds made up more than half the list of 20 biggest fee gatherers. The four Fidelity funds on the list generated management and performance fees of more than $1 billion, while management fees at the eight American Funds in the top 20 totaled nearly $2 billion.
Dolan noted the absence of any funds from Vanguard Group in the top 20, despite the fact that Vanguard runs five of the 20 largest mutual funds. She said this was due to the firm's at-cost structure -- Vanguard is owned by its fund shareholder so profits are passed back to them by way of lower fees -- and the fact that many of its funds are index-trackers.
Most of the funds in the top earners list did suffer some financial pain, as lower assets hit their bottom line. In their previous fiscal years, Growth Fund of America earned almost $500 million in management fees and EuroPacific Growth Fund had seen about $488 million in management fees.
One other fund saw management fees of more than $300 million in the most recent fiscal year: bond powerhouse Pimco Total Return Fund (FUND:PTTRX) , the world's biggest mutual fund which now has $200 billion in fixed-income assets, generated $330 million of management fees and total fees of more than $1 billion in its most recent fiscal year, which ended in March. That fund finished 2008 in the black, up 4.8%. The previous fiscal year, the fund made $272.7 million in management fees.
Only one other fund, Growth Fund of America, had total fees of more than $1 billion. Total fees for mutual funds include payments to third parties for legal work, customer service and record-keeping.
But it's not clear if the entire management fee goes directly to the fund company. That's because a lack of transparency in the area of fund fees makes it almost impossible to tell how much of the management fee is used, for instance, to pay commission to brokerage firms such as Charles Schwab Corp. (NASDAQ:SCHW) . Part of the total bill includes charges known as 12b-1 fees, which can cover broker commissions, but it's possible that management fees are also used.
"The accounting is very fuzzy because there's no clear standard for mutual funds to show where the money goes," Dolan said.
Disconnect on costs
Aside from where the money goes, there's also the issue of just how much money the fund companies are bringing in.
"The disconnect between the fees charged as a percentage and the absolute dollar amount the funds bring in becomes more and more astounding as a fund grows," said Dolan.
American Funds, for instance, is actually among the cheaper active managers on the market. But it still brings in huge amounts of cash because its funds are so large: for instance, Growth Fund of America's expense ratio is 0.75%, well below the roughly 1.1% average for a U.S. stock fund. But it has roughly $150 billion in assets, and the amount of money its fees raised suggest it could be cheaper still, Dolan said.
"Given the magnitude of dollars charged, we think it's fair to ask why more of those economies aren't being passed along to shareholders," Dolan noted in her study.
Dolan added, however, that calling for performance-based fees doesn't mean creating a hedge-fund-like system, where fees are decided each year and where managers can take 20% or more of returns for themselves.
"We don't want fees driven by one really good year or one really bad year -- you don't want funds to lay off their research analysts after a bad year," said Dolan.
Instead, she said, it would be better to see performance-based fees judged on longer time periods of three, five or even seven years.
"There is value in a longer-term outlook," added Dolan.
Growth Fund of America has five- and 10-year annualized returns of 3% and 2.7%, respectively -- in both cases putting it ahead of its category average and benchmark index, according to Morningstar.
Dolan also suggested that the dollar amount brought in by fees be expressed in terms of total returns delivered by a fund. For example, if a fund's returns in a year amounted to about $600 million, and it realized $300 million in management fees, investors would have a clear picture of how much fees affected returns.
Wednesday, December 30, 2009
Thursday, December 17, 2009
Investor Protection Act Highlights Conflict of Interest Problems
There are an estimated 88.5 million investors in U.S. mutual funds, but only a small fraction have ever heard of 12b-1 fees and revenue sharing deals. These are the two subterranean practices which create conflicts of interest between financial professionals and investors, and help drive down investor returns from their mutual fund investments.
But that may be changing.
The Investor Protection Act (IPA) has passed a key U.S, House of Representatives vote and it has some provisions which should alarm some load mutual fund company marketing and sales executives.
Specifically, the House bill gives the SEC more authority to adopt rules that require a broker or investment adviser "to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice."
While this sounds benign, and most investors probably assumed this was already the way their broker or investment adviser acted, the reality is very different.
Instead of providing investors with objective advice, too many financial professionals have been receiving revenue sharing deals, or in plain English, commissions, to steer investors into certain mutual funds as opposed to others. This advice is dispensed even if there is a better find which is more suitable to an investor.
The determining factor for too many investment professionals (and there are no official numbers to show the extent of this) is the size of this commission, or revenue sharing deal. The financial professional gets this commission (called a trail) for as long as an investor owns the mutual fund. In real life, this gives the seemingly objective investment professional a motive to keep an investor in a poorly performing or unsuitable fund just so they can continue to receive the commission.
To make matters worse, this commission is paid regardless of a fund's performance. In the current mutual fund market meltdown which saw funds falling by 25%, the revenue sharing deals were still being paid. This may explain why many exasperated investors asked their financial professional what they should do and they got a canned response: "Stay the course," or "Don't be a market timer," or "The rally could come at any time." In short, the investor assumed all the risk, while the broker still was being paid a commission.
The unethical aspects of this arrangement have finally attracted the attention of legislators and the SEC. This practice has been going on for years, but the powerful mutual fund investment lobby, the Investment Company Institute, downplays this embarrassing ethical abuse in a variety of way. Until recently they have simply avoided discussing it in public. As a matter of fact, the best way to dampen any mutual fund trade gathering is to publicly start a discussion regarding fees and expenses. It is simply a Pandora’s Box of conflicts and embarrassing details.
Ever hear of Fiduciary Responsibility?
As Peter J. Henning writes about the proposed SEC provisions regarding broker-dealer fiduciary duty: “The responsibilities of brokers to their customers does not involve the same level of protection as that imposed on investment advisers, who have a fiduciary duty to put the customer's interest first. What this means is that a stockbroker can recommend investments to a customer without a concern that the broker also receives a benefit from the transaction, such as commissions from a mutual fund company whose shares are recommended.”
Most surprising, Henning also writes that while the change has been requested by the SEC, “the securities industry has acknowledged (that) the current reality is hostile to brokers by supporting the higher fiduciary standard.” If the industry made this admission, it was only because they finally realize that hidden fee and revenue sharing deals cannot be tolerated any longer given the lousy returns most actively-managed funds delivered since the current recession began.
The Challenge for Mutual Fund Marketing and Sales Execs
For mutual fund marketing executives, the passage of the IPA by the House should send a shutter through the industry. If it passes in the Senate (and that is by no means assured since this is as contentious as health care reform), mutual fund company execs should finally realize that they are really in the commodities business.
The reality is that despite multi-million marketing budgets derived from 12b-1 fees, mutual fund marketers have not done a good job of explaining why there fund is different than another. Or, the other explanation is that there is not much difference between the 5,000 domestic large-cap growth funds (in all share classes) listed by Morningstar.
If some entrepreneurial financial analysts want to create a great Web site, just list the 12b-1 fees and revenue sharing deals of the top 100 mutual fund families, so investors can compare performance versus how much these fund companies were paying financial reps to buy their funds. This would be welcome news to shareholders, but very embarrassing to many fund complexes and mutual fund sales people.
So what should mutual fund marketing execs do in light of these impending new SEC regulations?
First, they should realize there will be a new way of selling and marketing funds. This means some new talent is needed.
Dismantling old-boy sales networks and competing on a fund’s merits will require:
--Creating more sophisticated, higher-level marketing messages;
--More knowledgeable marketing communicators and wholesalers who have the knowledge, credibility and ethics to acknowledge that competing products, such as ETFs, hedge funds, or managed futures, have distinct advantages over mutual funds.
--Marketers should be aware of the larger picture and consider that the entire role of mutual funds in investment and retirement wealth planning has been taken down a few notches.
The decline in housing prices, higher equity-risk premiums, a declining dollar and the rise of new middle-classes overseas all point to lower investment returns and managing investor expectations. Basically, it involves new ways of competing, innovating and thinking, which unfortunately, have not been strong points in the mutual fund industry.
Lastly, marketing and sales execs should openly acknowledge that the most important customer a load-mutual fund company has is their shareholders, not their fund wholesalers or the brokers who have been receiving their revenue sharing payments.
Source: What the SEC Gains from the Financial Bill
by Peter J. Henning
Thursday, December 17, 2009
Yahoo Finance
But that may be changing.
The Investor Protection Act (IPA) has passed a key U.S, House of Representatives vote and it has some provisions which should alarm some load mutual fund company marketing and sales executives.
Specifically, the House bill gives the SEC more authority to adopt rules that require a broker or investment adviser "to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice."
While this sounds benign, and most investors probably assumed this was already the way their broker or investment adviser acted, the reality is very different.
Instead of providing investors with objective advice, too many financial professionals have been receiving revenue sharing deals, or in plain English, commissions, to steer investors into certain mutual funds as opposed to others. This advice is dispensed even if there is a better find which is more suitable to an investor.
The determining factor for too many investment professionals (and there are no official numbers to show the extent of this) is the size of this commission, or revenue sharing deal. The financial professional gets this commission (called a trail) for as long as an investor owns the mutual fund. In real life, this gives the seemingly objective investment professional a motive to keep an investor in a poorly performing or unsuitable fund just so they can continue to receive the commission.
To make matters worse, this commission is paid regardless of a fund's performance. In the current mutual fund market meltdown which saw funds falling by 25%, the revenue sharing deals were still being paid. This may explain why many exasperated investors asked their financial professional what they should do and they got a canned response: "Stay the course," or "Don't be a market timer," or "The rally could come at any time." In short, the investor assumed all the risk, while the broker still was being paid a commission.
The unethical aspects of this arrangement have finally attracted the attention of legislators and the SEC. This practice has been going on for years, but the powerful mutual fund investment lobby, the Investment Company Institute, downplays this embarrassing ethical abuse in a variety of way. Until recently they have simply avoided discussing it in public. As a matter of fact, the best way to dampen any mutual fund trade gathering is to publicly start a discussion regarding fees and expenses. It is simply a Pandora’s Box of conflicts and embarrassing details.
Ever hear of Fiduciary Responsibility?
As Peter J. Henning writes about the proposed SEC provisions regarding broker-dealer fiduciary duty: “The responsibilities of brokers to their customers does not involve the same level of protection as that imposed on investment advisers, who have a fiduciary duty to put the customer's interest first. What this means is that a stockbroker can recommend investments to a customer without a concern that the broker also receives a benefit from the transaction, such as commissions from a mutual fund company whose shares are recommended.”
Most surprising, Henning also writes that while the change has been requested by the SEC, “the securities industry has acknowledged (that) the current reality is hostile to brokers by supporting the higher fiduciary standard.” If the industry made this admission, it was only because they finally realize that hidden fee and revenue sharing deals cannot be tolerated any longer given the lousy returns most actively-managed funds delivered since the current recession began.
The Challenge for Mutual Fund Marketing and Sales Execs
For mutual fund marketing executives, the passage of the IPA by the House should send a shutter through the industry. If it passes in the Senate (and that is by no means assured since this is as contentious as health care reform), mutual fund company execs should finally realize that they are really in the commodities business.
The reality is that despite multi-million marketing budgets derived from 12b-1 fees, mutual fund marketers have not done a good job of explaining why there fund is different than another. Or, the other explanation is that there is not much difference between the 5,000 domestic large-cap growth funds (in all share classes) listed by Morningstar.
If some entrepreneurial financial analysts want to create a great Web site, just list the 12b-1 fees and revenue sharing deals of the top 100 mutual fund families, so investors can compare performance versus how much these fund companies were paying financial reps to buy their funds. This would be welcome news to shareholders, but very embarrassing to many fund complexes and mutual fund sales people.
So what should mutual fund marketing execs do in light of these impending new SEC regulations?
First, they should realize there will be a new way of selling and marketing funds. This means some new talent is needed.
Dismantling old-boy sales networks and competing on a fund’s merits will require:
--Creating more sophisticated, higher-level marketing messages;
--More knowledgeable marketing communicators and wholesalers who have the knowledge, credibility and ethics to acknowledge that competing products, such as ETFs, hedge funds, or managed futures, have distinct advantages over mutual funds.
--Marketers should be aware of the larger picture and consider that the entire role of mutual funds in investment and retirement wealth planning has been taken down a few notches.
The decline in housing prices, higher equity-risk premiums, a declining dollar and the rise of new middle-classes overseas all point to lower investment returns and managing investor expectations. Basically, it involves new ways of competing, innovating and thinking, which unfortunately, have not been strong points in the mutual fund industry.
Lastly, marketing and sales execs should openly acknowledge that the most important customer a load-mutual fund company has is their shareholders, not their fund wholesalers or the brokers who have been receiving their revenue sharing payments.
Source: What the SEC Gains from the Financial Bill
by Peter J. Henning
Thursday, December 17, 2009
Yahoo Finance
Friday, December 11, 2009
A Small Step Forward for Investors
Today’s positive vote in the U.S. House of Representatives in favor of a modicum of financial reform is a bright light for investors. But it has a long way to go, especially as the U.S. Senate considers financial reform under the watchful eyes of the powerful financial industry lobby.
While financial reform is overdue, shareholders still must act in their own best interests regardless of the outcome. That’s because market returns going forward will be less than in the last, accompanied by more market volatility, a declining dollar and the prospect that the next generation of Americans will work in a nation which is competing for jobs and resources against emerging, powerful economies, especially India and China.
While the vote is in its early stages, it was certainly propelled by powerful populist forces which arose during the current jobless recovery (the worst jobless recovery ever was under the George Bush administration cycle with job losses continuing through August 2003, about two years after the 2001 recession ended*.)
The current jobless recovery and the failure of the Federal TARP program only underscore today's need for financial reform since it is now evident that financial self-regulation is a failure.
Another power force driving the need for financial reform is the bonuses paid out to executives of the top financial firms which ushered in the current deep recession.
Consider this list of bonuses awarded by firms which paid employees bonuses of at least $1 million or more in 2008:
JP Morgan Chase--1,144 employees;
Goldman Sachs—953 employees:
Citigroup Inc.—738 employees
Merrill Lynch—696 employees
Morgan Stanley—428 employees
Bank of America Corp.—172 employees
All of these bonuses were for work done as the U.S. was clearly entering the deepest financial crisis since the Great Depression; a recession which affected almost all aspects of the capital and real estate markets. It’s also safe to say that all of these firms received or befitted from direct funds in 2009 provided by U.S. taxpayers to keep these financial firms solvent.
*Source: Crunch, Jared Bernstein, Berrett Koehler, 2008
While financial reform is overdue, shareholders still must act in their own best interests regardless of the outcome. That’s because market returns going forward will be less than in the last, accompanied by more market volatility, a declining dollar and the prospect that the next generation of Americans will work in a nation which is competing for jobs and resources against emerging, powerful economies, especially India and China.
While the vote is in its early stages, it was certainly propelled by powerful populist forces which arose during the current jobless recovery (the worst jobless recovery ever was under the George Bush administration cycle with job losses continuing through August 2003, about two years after the 2001 recession ended*.)
The current jobless recovery and the failure of the Federal TARP program only underscore today's need for financial reform since it is now evident that financial self-regulation is a failure.
Another power force driving the need for financial reform is the bonuses paid out to executives of the top financial firms which ushered in the current deep recession.
Consider this list of bonuses awarded by firms which paid employees bonuses of at least $1 million or more in 2008:
JP Morgan Chase--1,144 employees;
Goldman Sachs—953 employees:
Citigroup Inc.—738 employees
Merrill Lynch—696 employees
Morgan Stanley—428 employees
Bank of America Corp.—172 employees
All of these bonuses were for work done as the U.S. was clearly entering the deepest financial crisis since the Great Depression; a recession which affected almost all aspects of the capital and real estate markets. It’s also safe to say that all of these firms received or befitted from direct funds in 2009 provided by U.S. taxpayers to keep these financial firms solvent.
*Source: Crunch, Jared Bernstein, Berrett Koehler, 2008
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