In an earlier piece I talked about how many of us don’t know how much we pay our FSPs (our financial services providers).
And I mentioned how this lack of knowledge came about because many of us are at our consumer-worst when it comes to FSPs and because some FSPs tend to hide that information, or at least not shout it from the hilltops.
Today we’ll look at an FSP who, much to its chagrin, had to shout it from the rooftops,
Now before going on, it’s important to state that we won’t be naming names in here. The primary motivation behind not naming names in here is our intention to keep the FHB at the generic, conceptual level, rather than at the specific, advisory level. That is in keeping with the public nature of this blog, and in keeping with making these pieces capable of general application.
It is also in keeping with the nature of blogging, which is to write ’em fast and get ’em out, which means that you should not expect intricately detailed, infinitely fact-checked pieces in here.
So the names haven’t been changed to protect the innocent, or to protect the guilty for that matter. Rather, the names have been left out because the idea here is to convey a general principal — to tell a story that has application well beyond the specifics.
By way of introduction, this is a money manager that gets its customers both going and coming, in the sense that this money manager both (a) runs mutual funds, and (b) helps its customers jump in and out of its mutual funds, and gets paid exceedingly well for doing so.
So these folks sell two different sorts of investment wrappers. The first investment wrapper is a familiar one — it’s a mutual fund wrapper. Here the company, in its role as an investment company, exchanges its customers’ cash for shares in a pool of investments, in the sense that, when its customers buy its mutual fund shares, they are putting money into the company’s investing pool which the company then invests, along with all the other money that has come into the pool before it.
Now this particular mutual fund family mostly does stock sector funds. Stock sector funds invest nearly all their cash into stocks of companies in a particular segment of the economy, such as health care stocks, financial stocks, technology stocks, utility stocks, etc., or in a particular geography , such as Europe (in this case, mostly the old Europe), emerging
The figure usually bandied about for the average cost of an actively managed, we-can-beat-the-market sort of mutual fund wrapper is 1.5% of assets under management per year. Bond mutual funds are typically substantially less than that, and quite a few stock funds are considerably more.
Now that 1.5% annual fee is not all inclusive. Most importantly, it doesn’t include trading costs. Yes, mutual funds have to pay stock commissions just like everyone else (well . . . almost like everyone else, but that is a topic for another day and perhaps even another blog). Trading costs show up as lesser gains or larger losses, rather than as part of the management fee the fund is required to disclose to the public.This is an incredibly complicated topic — probably intentionally so — so all of this is very much an overview.
Now, we won’t go into detail here about how great an idea that is or is not, but will note that, to most people’s way of thinking,sector-timing is something that should be left to professionals and to note that many people further believe that sector-timing shouldn’t even be entrusted to professionals because it simply doesn’t work.
And it’s pretty much beyond debate that none of the universally celebrated all-time great investors, like Peter Lynch, Warren Buffet and Benjamin Graham, made their mark using that technique, and mostly poo-poo’ed it.
So that’s what this company does: as an investment company it runs sector funds, and, wearing a different hat, this one the hat of an investment advisor, it helps customers jump back and forth between those sector funds.
This money manger is now going through the worst kind of nightmare, brought about by Ken Lay and Enron, Bernie Ebbers and MCI, who, with plenty of help from plenty of others, brought about the Sarbanes-Oxley Act. SOX, as it is often called, is a piece of corporate good-governance legislation that most public companies deeply despise. It has been good for accounting firms and technology firms, because it has added an entirely new layer to public companies’ bookkeeping chores, but keep-the-government-off-our-backs CEOs hate it hate it hate it.
Now, it’s hard to make heads or tails out of this money manager’s letter — perhaps intentionally so — but apparently, due to SOX, this money manager, because it changed its name, has to get many, and perhaps all, all of its customers to re-sign their account agreements and, worse still, in doing so it must highlight its fee schedule.
And that, right there, is a money manager’s worst nightmare, because the awful beauty of the AUM business model (the Assets Under Management business model) is that customers can, and usually do, totally forget about the fees they are paying. And that is a great business model: if the customer just does nothing (which is, after all, the easiest of all things to do), then the money manager gets paid.
And if the customer never looks at a statement (which is, after all, the easiest of things to do, especially when the statements bring nothing but woe and misery), then the customer won’t even have an inkling or a reminder of the fees the manager is receiving. And if the manager designs its statements so that its fees end up on the second to last page of a five- or twenty-page statement (entries on the last page being too noticeable), and also makes it hard to even know that the fee is a fee (what’s a debit? ), the manager can just keep going along, getting paid for . . . doing nothing (which is, after all, the easiest of things to do) or, worse still, getting paid for losing its customers’ money hand over fist.
So pity this poor money manager. My hunch is that when it changed its name at the beginning of this year it had no idea that it would have to have its clients re-sign their account agreements, and that then SOX came along and dropped a total bomb-shell on the name-change, i.e., needing to re-up with its customers.
That’s my hunch because I don’t think it would have changed its name if it had known that, not only would the name-change involve getting new stationery, but it would also require it to re-establish relations with each of its customers and disclose its fees in a big way.
But that is in fact what is now going on.
And what do you think its fees are? Well, I have read this letter several times and I am still not sure.
This much is clear, though. For the funds themselves, the AUM fees range from a low of 0.60% (for a plain vanilla bond fund) to 1.0% (for the stock sector funds). Those fees, in and of themselves, aren’t bad for actively managed mutual funds.
But it also charges for the sector-timing wrapper, and this is where jaws should probably drop because, unless you have over a million dollars under management with these folks, they will ding you anywhere from 0.17% to 0.25% of your assets per month. Per month!
Now let’s put this into perspective. You can buy really wonderful, really beautiful mutual funds — the kind that make you smile when you look at your ownership interest in them — that charge you that much per year. Per year!
So this company is twelve times more expensive than these really wonderful, really beautiful mutual funds.
So, do you think $2.50 gasoline is a rip? How about paying 12 times that much, or $30? Think about that: you go out and buy some gas and it costs you $30 a gallon. So it costs $300 bucks to drive your Prius 600 miles, and over a thousand to drive your SUV that far.
But if you bought your gas at a better, smarter gas station — one that shows some caring for its customers’ well-being — then you’d pay $2.50. Now the Prius trip costs $25 and the SUV trip costs $100
Well, how about paying the equivalent high-price for mutual funds? That’s the fee structure that this money manager is being required to disclose to its customers.
Now, those customers were given a chance to see that fee structure before, when they first signed on with the money manager. But that was a while ago, and the customers were probably brought in by an advisor they trusted, and who, unless they asked, probably did not highlight that fee structure during the sales pitch. Not a very sales’y thing to talk about, now is it?
One must emphasize benefits, not burdens, when doing sales, right?
It’s sell the holes; do not mention the price of the drill, right?
So let’s think about what this fee structure means in dollars and cents. It involves lots of zeroes, which means it’s hard for people to do in their head.
All, told, then, for a customer with, say, $250k on tap with this money manager, the tab for a yearly fill-up of mutual fund management and segment-timing would be $7,500, right?
One way to do the zeroes is as follows: 1% of $250k is $2.5k, right? But we’re talking about a 3% fee, which is 3 times the $2.5k fee we just calculated, and three times that $2.5k fee would be $7.5k, right?
And that’s owed whether the manager makes money or loses money for that customer. So, if the manager’s performance matches the market and the market goes up 6% in a year’s time, then the manager would get 3% and the customer would get to keep 3%. Likewise, if the market goes up 10% and the manager matches the market, the manager would get 3% and the customer would get to keep 7%. (Aside: the nuts ‘n bolts math is actually a bit more complicated than this simple subtraction, but usually the difference isn’t all that great.)
So the only time a customer’s account would ever match or beat the market is when the manager beat the market by 3% or more, right?
How often does that happen?
Well, that’s another topic for another day, but the short answer is this: it is really, really, really hard to beat the market on a consistent basis. Some do. But most do not. Indeed, most people who invest do not even match the market — and that’s true regardless of whether they invest with a little help from their friends the money managers or not.
But anyone who has to re-up with this company owed it to themselves to ask some questions about that topic before re-upping: they should ask the person who put them into the money manager’s business model (usually a registered investment advisor) to benchmark the performance of their accounts to a given benchmark that makes sense to use (which is a topic for another day).
And notice that we’re not talking about benchmarking the funds themselves, but rather are talking about benchmarking the customer’s particular account because, what with all the moving ins and moving outs and in-the-background fee-dingings, who’s to say or to know how your account matched up with a given fund?
So how’d the account do? If a customer’s account didn’t keep up with the benchmark, then shouldn’t t that customer consider whether it’s worth paying some company 3% to fail at accomplishing something, when there are plenty of companies out there willing to do try to accomplish the same thing for 1.5%. And if the customer simply wants to match the market rather than beat it (sounds nice for at least some of your money, doesn’t it?) then there are plenty of companies out there who are willing to try to accomplish that for the customer for a fee that is a whole lot less than that.
So Ken Lay and Bernie Ebbers might be criminals (go get ’em, Alberto, because John sure didn’t . . . ) and some of their cronies for sure are because they have pleaded guilty and are doing time.
But how about these sorts of money managers — these money manglers — the sort who charge exorbitant fees and in doing so virtually assure that their clients will underperform the market?
What they do is perfectly legal (assuming that they have dotted all their is and crossed all their Ts).
But is it right?
Are the people who sold this stuff to their customers doing the right thing by their customers, or are they simply looking out for their own interests, and in a rather twisted way? Is this a case, a la Microsoft, where marketing is everything? Forget about selling snow to the Eskimos; is this like selling scum- and bug-infested bottled water to the thirsty?
After all, how much of that 3% do you think goes back to the guy or gal who hitched the customers to the 3%-fee money managers in the first place? Maybe one percent?
So how does it feel to pay $2.5k to the guy who snookered you in the first place, and has caused you to trail the performance of the overall market by . . . oh, 3% ( if you were lucky)?
How does it feel to pay that dough to the guy who poisoned your well — the one you are going to rely on in your retirement years — when he hasn’t even called you in two years to see how you’re doing?
Hmmm . . .