Advisors To Funds: Straighten Out, Cut Fees

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Financial advisors are telling the $7.5 trillion mutual fund industry that winning back the confidence of investors means owning up to past mistakes and doing something about high fees.

Clients are concerned but much of that anxiety was registered between November 2003 and January 2004 when news of problems in the industry was breaking daily, says Ed Fulbright, a certified public accountant and financial advisor with Fulbright & Fulbright, Durham, N.C.

Companies might not have been “as up and up as they [clients] want them to be,” he continues. Consequently, Fulbright says he is partial to index-type funds.

“If you get a fund with higher expenses, your money is not working quite as hard and you are not taking quite the same risk,” he adds.

The good news, Fulbright continues, is that “clients understand what a mutual fund is supposed to do. There may be a few bad apples, but the industry is in pretty good shape.” Mutual funds are still an important investment option for clients, he says, because most dont have the assets to buy 100 shares of 50 different issues, but with a mutual fund, they can do it for a lot less risk.

But even if consumers need to continue to invest for the future, the mutual fund industrys transgressions “necessitate real change,” he adds.

“In those funds with blemishes, they need to throw out the bad people that have been identified. There were sheer abuses or people being extremely greedy. In some cases, the people they report to may have to go to make it seem worthwhile again,” says Fulbright.

Phillip Cook, a certified financial planner with Cook and Associates, Torrance, Calif., says his clients have been relatively quiet on the recent problems mutual funds have experienced. Even though they are aware of what is going on, they still view it as an important way to invest, he continues.

For those clients who do raise questions, Cook says he tries to make the analogy that “the safest airline to get on is one that just had an accident. Everyone is really on their toes and aware of the problems.”

Which clients are more likely to ask questions? Cook says they are the ones who are more involved in their investments, or as he puts it, “the not quite the do-it-yourselfers.”

Cook says the problems that have surfaced should never have happened. “It is really, really disappointing that they treated some shareholders better than others.”

If they had been thinking long term, Cook continues, they wouldnt have done something like this because sooner or later, such problems are found out. But people dont always think in the long term, he adds.

So, how should damage be repaired? “For a very, very long period of time, mutual funds must be shareholder oriented.” And, part of that orientation has to involve lower fees, he says. One of the precepts of asset management is that as assets under management increase, expenses should come down, Cook says.

Boards of directors also have to become more independent, replacing “the buddy system” with “truly independent members,” he adds.

Despite all the recent bad news, the good news, Cook maintains, is that “the mutual fund industry is still a valid, strong industry that is getting stronger. Im just glad that they caught the problem early enough.”

The issue of high fees was something that several advisors say mutual funds have to address.

“The real scandal has yet to make headlines,” says Russell Wild, a financial advisor with Global Portfolios, Allentown, Pa. “What has made headlines is the tip of an iceberg. Underneath, we find ridiculous management expenses, ludicrous turnover rates, asset-class drift, and constantly misleading advertising.

“Im a believer in the efficient market theory. Active management has its limitations. I dont think it is worth 2 or 3% or more,” Wild says.

Wild, who is registered with the National Association of Personal Financial Advisors, Arlington Heights, Ill., a fee-only organization, is skeptical about regulation solving industry problems.

“Yes, Ive had clients express concern. And yes, they should be concerned,” he says. “But no, greater regulation wont set the industry right. Investors still need to be careful about where they invest.

“In most cases, for most investors, the best avenues to diversification lie with low-cost, indexed mutual funds and exchange-traded funds. That was true before the recent scandals. That will still be true after the latest investigations have come and gone.”

“Clients are really fed up with the high fees. And, not only high fees, but hidden fees,” says Michael Jarjoura, director of asset management services with Wade Financial Group, Minneapolis. Fees can be 2% before you get started and if a fund has lackluster performance, it can hurt the client, he adds.

Jarjoura says his firm is planning to offer a product starting in September that would package individual stocks into a portfolio for a 1.4% fee.

But Global Portfolios Wild says that in order for the fund industry to restore confidence, a different direction is needed. “The scandals are shining a light in the wrong direction. They are examining trading irregularities that are not costing investors nearly as much as outrageous fees and churning.”

One instance of market timing that has been employed, he continues, is selling assets in funds prior to year-end so that the capital gains for potential shareholders wont be as great. As a result, existing shareholders pay for those gains, he adds.

That was certainly easier to hide when the market was doing well, but with lackluster to average returns, fees are a significant portion of that return, Wild says.

Index funds have been growing continually and exchange-traded funds will grow at the expense of regular funds, he adds. And, Wild says, of active management, “it is like astrology. You will always get someone who believes in it.”


Reproduced from National Underwriter Edition, July 22, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.