Pair take aim at asset-allocation ads

Two men schooled in scientific rigor are taking aim at mutual fund marketers, alleging they’ve misquoted research on the importance of asset allocation to help lure new clients to buy expensive services. Chances are slim the Ontario Securities Commission will chase after refunds for tens of thousands of investors. The link between sales and marketing claims would be hard to prove. But knowing their concerns might reduce your own chances of being misled. Retired physics professor John Nuttall complained to the OSC in 1999, and then again last year. Executive director Charles Macfarlane replied in a letter last year that staff would look into two fund managers, one said to have misquoted research findings in sales materials and another reported to have failed to cite the source. Now Ken Kivenko, a former president of Allied- Signal Aerospace Canada and a volunteer for the Small Investor Protection Association, has urged the OSC to speak up publicly.

“ All I am asking is for the OSC to direct the fund companies to correct their advertising,” Kivenko urged Macfarlane. He estimates financial companies could have been generating up to $540 million a year in mutual fund management fees from by the small percentage of clients attracted by an asset allocation service.

Half of that estimate would surpass in a single year the OSC’s $205.7 million settlement with five mutual fund companies that had permitted market timers to hijack unit holders’ profits, he notes.

Nuttall states in a paper posted on the Web at http:// publish. uwo. ca/~ jnuttall/ that he and his daughter originally collected about 50 misleading references to the 1986 and 1991 papers by a research team led by Gary P. Brinson, a widely respected U. S. institutional money manager. Here is how Brinson summarized his original findings, with the addition of some definitions from Nuttall’s paper:

“ Data from 91 large U. S. pension plans over the 1974- 83 period indicate that investment policy ( that is, the choice of asset classes, such as stocks, bonds and short- term securities, and what proportions to hold) dominates investment strategy ( that is, the selection of securities, the timing of purchases and the reweighting of portfolios), explaining on average 93.6 per cent of the variation ( a measure of how much quarterly returns fluctuated relative to a 10- year average return) in total ( pension) plan return. . . . On average, ( investment) policy returns accounted for 91.5 per cent of the variance of actual returns.”

That’s not easy to follow, and it may not even be right. Nuttall uses mathematical formulae ( beyond my understanding) to question his conclusions as others have done. But his primary concern is marketing materials and fund managers’ websites frequently omit the words average, variance and pension plans, and never mention Brinson’s admittedly unsupported conclusion that fund managers who beat market returns are just lucky, not skilled.

Nuttall suspects investors who see the abridged claims about asset allocation will expect higher returns with lower risk if they use an investment professional’s asset allocation service. Yet his research leads him to believe the selection of the mix of assets will be less significant than the choice of asset classes, the individual securities selected and timely shifts in asset mix. These choices require skill, and speculation about the future.

Nuttall does not take a position on whether the outcome will be a matter of luck or skill. He merely argues it makes no sense for investment companies to rely on Brinson’s early findings to promote asset allocation and then ignore his observation about investment choice being a matter of luck in order to direct clients to their actively managed mutual funds.

“ It would be obvious that they have no reason to charge management fees for the equity portion of an asset allocation program much beyond those charged by an index fund,” Nuttall told Macfarlane a year ago. Nor does it make sense to Nuttall that companies should imply they can optimize the risk and return of a client’s portfolio without providing evidence that they know how.

Kivenko says he does not quibble with the right of investment companies to charge high management fees, as long as they do not lure clients with selective use or misrepresentations of disputed academic research. He points out that Brinson’s research was based on pension funds. So it is totally inappropriate to make use of figures in the 90 per cent range for the influence of asset allocation using mutual funds because of the difference in the amount deducted for management expenses — an average of about 2.5 per cent of assets each year for mutual funds compared with a fifth of that in pension funds.

In addition, Kivenko points out that bond mutual funds are no substitute for individual bonds that are held to maturity within a pension plan or individual’s portfolio.

If they are right, we need to ask more questions before we trust an asset allocation service involving costly mutual funds. James Daw, CFP, appears Tuesday, Thursday and Saturday. He can be reached at Business, 1 Yonge St., Toronto M5E 1E6; at 416-945-8633; 416-865-3630 by fax; or at jdaw@thestar.ca by email.