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Evaluating “Retail” Investment Managers

| | Posted in: Individual Investing, Investing Expertise

Readers recently requested evaluations of two different retail investment managers. Our reviews involve simply putting the information the firms make available on their web sites into the context of broad stock market research. Our findings for the two firms are similar, as follows:

Both of these investment management firms:

1. Serve clients by selecting and buying/selling mutual funds and/or exchange traded funds on their behalf.

2. Provide no specific information on the web regarding their past investing performance.

3. State that they charge clients fees based on a percentage of assets under management, ranging from 0.9% to 2.0% annually, depending on size and type of account. These fees are independent of investment performance and, of course, are in addition to any fees/costs charged by the funds used as investment vehicles.

The following figure illustrates the consequences of the compounded fees noted in the third point above. Using the data from Chart 23 from John Bogle’s May 2006 speech on “What’s Ahead for Stocks and Bonds – And How to Earn Your Fair Share”, we (conservatively) assume that the typical equity mutual fund charges investors 1.5% annually in total fees/costs. Based on the third point above, we assume that the typical “retail” investment manager charges an annual fee of 1.5%. If the investment manager selects for clients mutual funds with an aggregate gross return matching that of the S&P 500 index (an average of 9.1% per year for 1951-2006), the investment manager’s fee represents on average about one sixth of the gross mutual fund return. The combined fees of the investment manager and the mutual fund manager represent on average about one third of the gross mutual fund return. One third is a substantial average return headwind for clients.

Unless an investment manager can consistently pick strongly outperforming funds, an investor would do better by buying and holding a low-fee index fund directly. If the investor’s account is not tax-sheltered, the investment manager may have to generate even greater outperformance to overcome taxes incurred by trading in and out of funds. When deciding whether to use an investment manager, an individual investor should therefore request from candidates actual long-run, after-fee, average performance data and trading activity data.

In summary, in the absence of equity investment manager performance data that demonstrates strong and persistent net outperformance of the broad market, individual investors are likely better off buying and holding low-cost index funds directly.

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