Q. I would appreciate your helping me with a decision concerning the management of our assets. We have assets (several hundred thousand dollars in a taxed account and three times that in tax deferred accounts) invested in families of mutual funds. Our financial adviser suggests that we hire a group of money manager--- one, a value style manager and the other,  a growth style manager--- to manager our assets for us. The fee would be 2.5% of the amount invested per year, part of which goes to the investment house for acting as a liaison and monitoring the money managers. The managers would liquidate all or a part of our mutual fund assets and purchase equities in a diversified portfolio.

I have several questions:
  • Over a long period, is there a difference in the returns gained from a money manager investing in specific equities over a our investing in a family of quality mutual funds such as America Funds, Putnam Funds, etc.?
  • Are there sufficient tax issues resulting from the need to pay capital gains tax annually on mutual fund gains versus the deferral of capital gains taxes by holding individual securities that there is an advantage to one investment design over the other?
  • Are there ways to select a money manager other than using a brokerage firm as the liaison if the investor is naive in how to select and monitor the manager? Is 2.5% an appropriate fee?


  • My wife and I are in our mid fifties and are hoping to continue working only another 2-3 years. We have discussed these issues with our financial adviser and our attorney and are getting mixed messages.

    ---L. B., San Antonio (by e-mail)

     

    A. You've been offered a "wrap" account. Services are bundled and your money managed for an annual fee based on your assets rather than for fees based on transactions. In theory, this puts the broker on your side of the table because you no longer have the built-in conflict of interest over commissions. Unfortunately, the major brokerage houses accomplish this at the probable expense of future performance--- the fees are coming straight out of your investment return.

    They will, of course, protest that they have superior ability to pick money managers and that they will fire money managers who fail to perform. They might also imply that only through a firm as large as theirs could a miserable peasant--- a person like  yourself, for instance--- have access to the brilliant minds that make gobs of money.

    In fact, I believe it is all defensive marketing to sustain the brokerage firms' return on your assets. Yes, you read that right--- the brokerage firms' return on your assets. With the assets that you cite, you could go to an independent money management firm and have your funds managed for about 1 percent a year. At the very least, you should explore that option. You should also know that these fees can be negotiated: a recent report by Cerulli Associates, a Boston financial services consulting firm, indicted that the average consultant wrap program fee had declined to 1.89 percent, down from 2.11 percent in 1998 while the average account size also declined to $148,000. Given your assets, you should have enough bargaining power to get the cost down.

    One of the common arguments for paying the fees is that it's a small price to pay for superior performance. The problem is that managers are paid regardless of their performance and the fee, in itself, is a good predictor of mediocre performance. Remember, long term, more than 70 percent of all money managers fail to beat the S&P 500 Index. Over time, an extra 1 percent a year in fees will reduce your investment performance.

    This doesn't mean that your broker and his selected managers aren't smart, well educated, insightful, articulate, and altogether charming individuals. It just means that it is difficult to overcome their expense.

    Yes, I know that 1 percent affecting your performance sounds far fetched. But it does. Let me give you an example: in a recent 12 month period, the difference between the 25th percentile domestic balanced fund and the 75th percentile balanced was an impressive 8.26 percent. Against that background, spending 2.0 or 2.50 percent a year looks plausible.

    But over the last 15 years the spread was only 2.24 percent.

    Expenses matter. They always matter.

    If you need a lot of handholding and guidance, you may need to stay in higher expense wrap account but I see them as a marketing tool that moves the managers away from standard, measured performance comparisons.