Thursday, 8 October 2009

Thoughts for the Active Management Mutual Fund Industry

Ottawa Business Journal wrote about the new Investment Partners Fund which has a completely different fee structure from the usual 2% or so annual MER charged by the average Canadian equity mutual fund. The fund managers will only charge a fee if returns exceed 5% in a year. If the fund loses money or makes weak returns, no fee! Over 5% return, they will charge 0.25% for every 1% (or part) return. If the fund was to get a 9% return, which would be quite an achievement, that would be a 1% fee for the year, pretty darn reasonable.

Only thing the article doesn't mention is whether the fund may or will use leveraging (borrow extra money) to try juicing returns, which of course the managers have extra incentive to do. I'd certainly want to see a restriction on borrowing in the fund policy. Otherwise the risk of loss goes way up. Make it a pure stock picking challenge.

Unfortunately the fund is only open to accredited investors, i.e. rich people or professional investors.

But it does offer an idea to our over-charging fund industry.


Preet Banerjee said...

Note that for the 15 calendar years for the TSX total return ending 2008 charging 2% per year for 15 years would be obviously an average of 2%, but with this fee structure the average fee would've been 2.49%.

CanadianInvestor said...

Good point, Preet. The reason is the volatility of the TSX - it isn't often that actual returns are near long term averages. Looking at the TSX from 1970 to 2007 (data from Libra Management, thanks very much), there were 11 down or poor years (2008 would have made 12) when the fund would have paid no fees but the other good years more than made up for that e.g. 1979, when the TSX rose 45%, meaning there would have been a 10% management fee. The 0.25 fee rate is too high to make up for the down year protection. (The 1970 to 2007 average fee for this fund would have been 2.66%) To make a pre-tax portfolio with equal end value from 1970 to 2007 the fee would have to have been about 0.21%. Anything below that, this variable fee option looks better. The rate is too high!

I also discovered that the total value of the portfolio as it evolves year to year would track the flat 2% rate portfolio movements very closely so this new fund would provide no benefit to the investor in smoothing out the volatility.

Since the fund intends to be an active stock picker and not to track the TSX, it will likely be even more volatile, accentuating the fee effects.

One has to wonder how they decided on their fee. Did they test back data like this simple stuff you and I just did and say to themselves that they deserve the extra fee for the psychological (but not real) comfort they provide. Or did they just slap a nice round number with plenty of upside potential to make up for years when they don't get paid?

In other words, I'm gonna revise my opinion. This new fund seems to offer only a false promise of benefit - it's just a marketing ploy.

Rather than be a model for the mutual fund industry to think of emulating, it is just the type of thing investors do not need - complication and illusory benefit with no real advantage. The guy should stick to selling car parts where over-charging at least doesn't ruin your retirement.

Thanks very much for waking me up.

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