Covestor and CVIM Blog

Tough Times for Funds

Tough times for everyone but looks like it is beginning to get particularly challenging for those overcharging, under performing funds. It was always bound to come, but given the recession investors are talking with their feet and the incumbents are beginning to find life difficult.

Two recent stories only go to highlight the challenges faced by the industry. Bloomberg is reporting huge job losses in Hedge funds and that a staggering 70% lost money in 2008:

Hedge funds may cut 20,000 workers worldwide this year, a record 14 percent of the industry’s jobs, as investment losses and client withdrawals erode fees.

About 920 hedge funds, or 12 percent, closed last year, according to data compiled by Chicago-based Hedge Fund Research Inc. Of the 6,800 single-manager funds that remain, 70 percent lost money in 2008, meaning they can’t resume collecting performance fees until the losses are recouped. Those fees, generally 20 percent of investment profits, are the primary source of cash used to pay bonuses.

In even more telling news the Supreme court has agreed to hear a case that will determine whether investors can blame a fund's advisers for excessive charges:

At its heart, the case speaks to the way fees are set across the mutual fund industry, and, depending on the court’s decision, could radically change how much shareholders pay in the future. “Millions of people invest in mutual funds,” said William Birdthistle, a professor of securities law at Illinois Institute of Technology's Chicago-Kent College of Law. “This touches everyone.”

Covestor was established to bring transparency to the fund management industry, to enable ordinary investors to challenge the incumbents. That is becoming more of a reality daily and it is great to have you on the journey.

Investors Pulling Out of Funds

The Financial Times ran an interesting piece this weekend about Investors worldwide pulling almost $100bn out of equity funds in the first three months of this year - a record shift, and part of a long term trend away from the US market. The article goes on:

The outflows also accelerate a trend for investors to put their money either in ultra-safe cash options such as money market funds, or into riskier markets and high-fee products such as hedge funds. They are abandoning the middle ground of mainstream equity and fixed income funds, especially in the developed markets.

At the same time money market funds have seen record inflow's, adding c$140bn in the same period.

There is clearly a great deal of cash out there waiting for markets to stabilize. Albeit much of the current outflow is caused by the credit squeeze, with low cost ETFs on one side, and the democratization of active money management on the other (e.g. on Covestor), unless they pick up their own performance and transparency who would argue that these funds will flow back.

The Economist: Special Report on Asset Management

The current edition of The Economist has a special report on asset management.  The first article, by Philip Coggan, The Economist's Capital Markets Editor, highlights how the fund management industry has and continued to do very well, but for itself.  Here's a quote from the introductory paragraph:

Imagine a business in which other people hand you their money to look after and pay you handsomely for doing so.  Even better, your fees go up every year, even if you are hopeless at the job.  It sounds perfect.  That business exists.  It is called fund management.

The article goes on to report that the average profit margin that fund managers who took part in a Boston Consulting Group survey was an astonishing 42%.  Fees tend to grow 15% per year despite the industry's vast size - Watson Wyatt estimated value of all professionally managed assets of more than $64 trillion at the end of 2006.  And despite the introduction of lower cost alternatives, such as index tracking funds and ETFs, fund managers have been very successful at maintaining their high fees.

If you have any stories of rip off funds, we'd love to hear from you.  Or why not ask your fund manager to join Covestor to showcase the value they truly provide.

You can read the full Economist report here.

Mutual Fund Fees On Fees

We received an E*Trade marketing email on friday advertising a new fund.  The subject line sounded sensible: "how to survive an up-down market". But looking closer, there was no great insight. The conlcusion was to diversify. Less likely to help you to survive the market, than to better correlate to the ups and the downs. In fact digging deeper the Beta of the fund to the S&P was 0.98.   

The pont for us at Covestor is that these sorts of instruments are just plain bad for consumers. In this example the product was a fund of funds that looks, acts and markets itself as an index tracker. So while their gross expense ratio is not excessive for actively managed money (1.82% gross expense) - that's not the real cost compared to a simple index tracking ETF.  They are investing in funds that themselves charge fees. Fees on fees.It is worthwhile paying for talent, but can't be sensible to pay a premium for a product that chases the average.

Scale Benefits In Fund Management

An interesting round-table discussion was posted on 12.10 in Pensions and Investments (The Journal of International Money Management) about the changing face of value of investment management firms. It highlights how despite the credit crunch, there is continued client demand for alternative investments (i.e. hedge funds) which is driving both the compensation of individual fund managers, and the search for asset management talent.   

Particularly interesting is the comment on scale in fund management business:

We believe that there’s scale that happens in some specific distribution channels. There’s scale that happens by having more assets in a particular product strategy, which does work. And there are some scale advantages particularly in retail on the operations, technology and branding side. But it’s going to be scale within those silos rather than an overall asset level that really drives benefit in the industry.

This resonates with what we are doing at Covestor.  The world has changed and, as we continue to see from our members, talent is clearly not limited to the old institutions.  Scale benefits are no longer to be found in piling money into one mega-fund that chases an index, but in the platform for all talented investors to exploit their individual strategies.

Underperforming Funds: Spot the Dog

The London Times this weekend highlighted a great report by Bestinvest, the Indepedent Financial Advisor, on the huge growth in the amount of money sitting in underperforming funds:

"The number of poor-performing, or “dog”, investment funds has nearly doubled in the past 18 months, according to a new study. Bestinvest, the independent financial adviser, says that about £13 billion of investors’ money is languishing in these funds, compared with just £3.3 billion 18 months ago. There are now 72 dog funds, almost twice as many as there were in January 2006. To qualify for dog status, a fund must have underperformed its benchmark in each of the past three years and by at least 10 per cent over that period." You can download the full report by clicking here.

This is what Covestor is all about changing. Money sitting in expensive underperforming funds and not invested alongside brilliant self directed investors- doing it with their own money. If you have examples of poor performing funds let us know and we will do what we can to name and shame them on the site

How the Rich Invest

There was an excellent post yesterday in the Wall Street Journal Online on How the Rich Invest.

The summary was:  the rich don't invest in ETFs and Mutual Funds - but allocate more to actively managed opportunities like Hedge funds that are out of the reach of the less rich.  Grossly oversimplifying the article - the cut off for Rich in this case is $5m-10m range and the reason they don't invest in ETFs and Mutual Funds is they CAN invest in other actively managed instruments wheras the small guy (sub $1m assets) can't.

But the article also ends

Hedge funds and private equity also remain largely the purview of the wealthy, since their minimum investment levels are often in the millions (granted, fund of funds and pensions have made it a little easier for the little guy to get in).

That’s not to say that hedge funds and private equity returns are necessarily BETTER than mutual funds and ETFs. With returns for “private money” under pressure, with fees going up, and investments becoming more and more correlated, I would argue that while the rich may have more exlcusive investments, they don’t always get better returns.

and that is precisely  what we are all about at Covestor.  The institutions don't have any lock on talent and the world's changed - thanks to the SEC and the Internet - I have the same access and costs as the big hedge funds or bloated mutual fund managers - so there should be a free market, and a way for real talent to shine and be rewarded.

Excellent Seeking Alpha ETF investment guide

We are going to post this directly from the full article because it is such a great piece about Financial advisors fees.

"Brokers, Financial Advisors, & Investing for the Wealthy

• The traditional broker-client relationship is crippled by a fundamental conflict of interest: the broker is not directly compensated for giving objective advice, and is incentivized to maximize fees (My Broker's an Honest Fox).
• Asset-based-fees go some way to reducing brokers’ conflicts of interest. But they don’t solve all conflicts of interest, they incentivize the broker to spend too much time prospecting for new accounts, and they take a sizable chunk out of clients’ investment returns (Asset-Based Fees to the Rescue).
• Asset-based-fees could cut investor returns by 25% based on current market forecasts (But What if You Saved $275k Annually?).
• Many independent financial advisors also charge-asset based-fees. If you need to consult a financial advisor, it’s generally better to negotiate an hourly fee instead (Financial Advisors).
• Commoditization of financial products - particularly of index funds and online brokerage services - has steadily driven costs down and improved product quality. Fees for less commoditized financial products, such as managed accounts and actively managed mutual funds, have actually risen. As a result, wealthy investors shMe, Use an Online Broker? But I'm Rich!).
• Separately managed accounts are the darling of the investment industry because they attract wealthy clients and charge hefty recurring fees. But the overall underperformance of investment managers versus their index benchmarks (Why You Shouldn’t Buy Mutual Funds) and the crippling impact of high fees (But What if You Saved $275k Annually?) means that separately managed accounts are generally a bad deal for investors (Separately Managed Accounts (SMAs)).
• Most wealthy investors over-estimate their need for investment advice. Management of a portfolio of eight to twelve ETFs (A Core ETF Portfolio) in an online account (Which Brokerages Come Out Best?) is easy and not time consuming, and likely provides better diversification and overall performance than most High Net (financial) Worth financial services using individual stocks and mutual funds (What Not To Do).
• For a $10 million account, a basket of ETFs managed in an online brokerage account should outperform an asset-based-fee account targeted at wealthy individuals by about $275,000 per year, by my estimate (But What if You Saved $275k Annually?).
• If you need customized advice and products, split your assets between an active manager and an online brokerage to minimize fees. Use the online brokerage to manage the majority of your assets in ETFs. Ensure that the active manager is directly compensated for objective advice, fully discloses all fees, and provides a fully documented track record (What to Do With What's Left?)."

Why is there so little information about Fund Managers?

We have spent a good part of the day trying to find information about Fund Managers to create accounts for them on Covestor to let members compare their own performance to. What is surprising is how little information is available relating to these individuals.

Searching through the 100 largest funds for photographs of the managers very few are publically available on the web. Even simply trying to find out who the current manager of a fund is proves to be a difficult job - with considerable difference between the manager listed on Yahoo vs Google finance. When we create portfolios for these people we plan to invite them to update their own details and lets hope they choose to take this up. It seems important to know who the people managing these huge funds are, and although 'fund of fund' managers may have good access to them shouldn't we all know a bit about the people who are managing our money

Bookmarks for May 16

Some good reading on oversized funds and some of the stock blogs we are reading at the moment:

• Why fat funds need diets: Excellent Kiplinger article from May edition on why money piling into funds affects their performance
• Remember what Buffet said about HF fees?: Warren buffets shareholder statement about the 'grotesque' size of Hedge Fund fees
• Are your interests really aligned with your fund managers?: Fairly old MSNBC article but good warning to keep in mind
• Three bloggers we are reading
  
  • Asif Surias' great SINletter: Includes excellent model portfolio and Asifs disclosure of his true holdings (great stuff)
  • Yaser Anwars' investment ideas: Always insightful and detailed - great analysis - we want to hear more about what he is doing with his own money...
  • Roger Ehrenbergs' information arbitrage: Always insightful - well worth following