Choosing the right manager can be gamble
These days, making a living in bank accounts or GICS, bonds or in stocks is tough. A bank deposit that pays a couple of per cent a year passes for a shrewd investment, even though what’s left after tax and inflation may be next to nothing. That’s the dilemma for investors who can try to get a return or try to find a manager who will do it for them.
“Interest rates on fixed income investments are so ridiculously low that you can’t even consider them as a viable option for your future financial security,” says Bill Beatty, an Edmontonbased telecommunications company manager who hopes to retire in seven years or less and prefers not to take big risks with his money. “I think we’re forced to rely on money managers who, we hope, can make up some money. Trouble is, finding those managers is very hard. And paying them is a gamble.”
That’s the dilemma: Find a manager who may or may not be worth his fees or save the fees and risk being pennywise and pound foolish. After all, a couple of bad days in the market can cost more than a few per cent paid to a manager.
Only a handful of managers have the skill to do well for their clients
“The picture of what mom and pop investors have achieved in this market is bleak,” says Dan Hallett, director of asset management for Highview Financial Group in Oakville, Ont. “Individuals trade too often, give up too much return in fund and trading fees and taxes, make bad timing decisions, and generally underperform the market.”
Unfortunately, fund managers on average have not done a lot better than markets.
For example, Canadian money market funds posted an average 0.42% return for the whole of 2011. That rate would have generated $ 420 before tax. At least that was a positive return. The S& P/ TSX Composite Index lost 11.1% in the year. Even balanced mutual funds that are constructed to reduce risk lost 3.9% in the year.
Retail investors know they need guidance. The quest is therefore to find a manager who justifies his or her fees. The average fee on equity funds is 2.5%. The average fee on bond funds is 1.5% per year, enough to confiscate most of what little interest government bonds pay.
“If you look at the overall market, only a handful of managers have the skill to do well for their clients. The rest don’t do well or are inconsistent,” says Som Seif, president of Claymore Investments Inc. in Toronto.
Some managers add value to market returns. James Hymas’s Toronto- based Malachite Aggressive Preferred Fund, for example, produced a 14.8% average annual gain for the five years ended Jan. 31, 2012 vs. the 4.15% average annual gain of its benchmark, the BMO Capital Markets 50 Index.
His fees, which start at 1.34% of net asset value and drop as amounts invested grow, are below average.
His style is the rigorous fundamental analysis used for fixed income assets — balance sheets, study of corporate capital structure, and a good deal of what one might call iconoclastic beliefs in the market. His territory, preferred shares, is usually ignored by other managers. But his returns show that a maverick manager who does not follow the market can perform well for clients.
It has to be said that not every investment goal needs a manager. If an investor wants nothing more than a 10- year Government of Canada bond to provide a sum of money known to the penny every year to maturity in 2022, there is no need for a manager, says Caroline Nalbantoglu, a registered financial planner who heads Cnal Financial Planning Inc. in Montreal. “You just buy the bond and hold the position until maturity. You have the guarantee of the government and the certainty of getting interest precisely on schedule. It does not pay much, but there is no risk of default.”
There is a middle ground for investors — exchange traded funds — where fees and performance are in a potentially reasonable balance.
A new generation of index funds tries to maintain the advantages of active investing, selecting stocks for various merits such as free cash flow per share, says Mr. Seif.
That puts the fund in a space between traditional active management in which managers follow themes or their favourite valuation models and the low costs of passive investing in index funds. The new generation can add value to index funds, he says.
The Claymore S& P/ TSX Canadian Dividend ETF ( CDZ- TSX) returned 19.19% per year compounded annually for the three years ended Dec. 31, 2011 compared to the S& P TSX 60 total return index, which gained 10.95% in the same three- year period.
In the competitive fund and ETF market, it is essential to look at track records to find not just hot recent performance, but consistent performance. Look at fees and compare the costs with those of peers. Over time, fees shift a lot of gains to managers, Ms. Nalbantoglu notes. “The point of hiring a manager is to get value for fees. That is at least as hard as picking stocks.”