Fund Managers: Concerned with Their Bottom Line, Not Yours

Mutual fund managers like to encourage their clients to believe that they're in a partnership, working in harmony in pursuit of long-term financial success. To be sure, mutual fund managers would certainly be happy to see their clients succeed. But there is a limit on how much they're willing to cooperate to help them do so. Rather than a partnership, investors' relationships with mutual fund providers is more akin to the one a sheep has with a shearer -- they're a source of income. And the sooner investors recognize that reality, the better their odds for success.

Of course, mutual fund managers don't want investors to think of their relationship in those terms, which is why newspapers and magazines are filled with advertisements describing how eager they are to offer their expertise and abilities, collaborating with individuals as they navigate the market's ups and downs in the pursuit of long-term goals.

But every once in a while the veil slips, and a mutual fund executive reveals the true nature of the investor/fund manager relationship.

A fine example was contained in the November 23 issue of Investment News. In a story on New York Life's hunt for fund managers to acquire, executive vice president Chris Blunt said "we're looking for a firm with about $15 [billion] to $25 billion with funds that have strong track records." Why? Blunt explained it simply: "Our fund complex makes very little money. We are right at the break-even point and buying a fund business would contribute to our bottom line."

Nothing about whether such an acquisition would benefit the owners of his firm's mutual funds, nor any concern about whether the owners of the acquired funds would benefit from such a transaction. The decision is simply a matter of improving New York Life's bottom line. Sheep, meet the shearer.

The true nature -- and economic consequences -- of this relationship were laid out quite clearly to the United States Supreme Court. Tucked away amidst the reams of information filed in the recent Jones v. Harris Associates case was a table detailing the expense ratios that various Harris Associates clients were charged for asset management services.

In the large-cap category, for instance, the Supreme Court was told that one of Harris's institutional clients was charged 0.45 percent on assets of $160 million. Shareholders of Harris's large-cap Oakmark fund, on the other hand, paid an expense ratio of 0.88 percent on assets of $6.3 billion.

An expense ratio that's nearly twice as high for the same service might raise an eyebrow or two, but that doesn't begin to tell the true story.

Hopefully an enterprising member of the Supreme Court staff will do a little basic arithmetic, and multiply those figures together. Doing so, we learn that Harris's institutional client paid total fees of $720,000 (0.45 percent x $160 million), while their mutual fund clients paid $55 million -- or more than 75 times as much.

Clearly, $55 million would provide quite a contribution to a firm's bottom line -- much more than a mere $720,000 -- so it's little wonder why fund managers are so intent on increasing their mutual fund assets under management. And perhaps the Supreme Court will agree that this fee disparity (which is hardly unusual in the industry) is an indication that the relationship between fund investors and managers is much too one-sided.

But regardless of what the Supreme Court ultimately decides, investors will be well-served to cease viewing their relationship with their asset manager as a partnership, and rather see it as one of opposing interests. Doing so will be the first step towards ensuring that the bottom line that's being boosted is not their fund manager's, but their own.