1. You may have more investing experience than I do.
The first step when selecting a money manager is reviewing his or her track record, which provides information about past performance and returns as well as investment style. A manager without a track record should raise a red flag, especially for an investor who s looking to place money in experienced hands.
If they don t have a track record, there s no real compelling reason to take a risk, says Gary Schatsky, an attorney and fee-only financial advisor in New York.
Often, investors are concerned about ending up with a young money manager, but age shouldn t be the focus of their search because it does not always speak to experience, he says. Instead, investors should look at how long the people they're considering have worked as money managers and check how their performance compares to investing benchmarks like bond funds or the S&P 500.
Currently, 546 out of the 2,729 domestic equity funds have managers with an average tenure of two years or less, according to Morningstar. And more than half (280) performed worse than the S&P 500 s 12-month return ending July 31 of 13.84%.
2. I ll beat the market someday.
It s not easy to find a money manager who consistently beats the market. That s not so bad when the market is up and your fund is up a little less; it s worse when the market is down and you re down more.
Lagging returns have been a common problem since the recession that began in December 2007.
When virtually all indices are dropping the best you can hope for are comparatively better returns, which in many cases are negative just with a lower rate, in the same asset class, says Schatsky. But it takes a rare client to embrace that and recognize comparative value.
Investors who are shopping for a money manager should focus on their past performance not just over the one-, three- or 10-year periods but specifically during bear markets to have a better understanding of how they adjust their investing tactics and how they react to market losses. Compare their performance to similar funds and, if applicable, to the index itself, says Schtasky. You want to see that they have performed well to the benchmark, he says.
3. Hedge funds aren t what they used to be.
Once reserved for the super-rich, hedge funds today are quite common and accessible to the average investor. Assets in hedge funds climbed 10% during the second half of 2009 to finish the year at $1.82 trillion, according to HedgeFund Intelligence. However, they haven t been immune to the market downturn. That bump followed an 18-month period during which the hedge fund industry contracted by more than 30% and fell off its 2007 peak of $2.7 trillion in assets.
The funds' recent, relatively poor performance has caused some high-profile hedge fund managers to close up shop. In August, fund manager Stanley Druckenmiller, whose firm Duquesne Capital Management holds about $12 billion in assets under management and has averaged gains of about 30% over the past two decades, announced he would be closing the fund, citing disappointing returns.
Most hedge funds charge a management fee of around 2% of assets, and they charge a performance fee, which is often around 20% of portfolio gains. The performance fee doesn t necessarily kick in right away; typically, the contract an investor signs with a hedge fund states that the fund must meet a certain level of performance first.
4. The name might be the same, but a new manager means a whole new fund.
Many investors pick a fund not for the company, but for the manager who will be overseeing their money. However, the manager investors get when they buy in won't necessarily remain with the fund until they cash out. On average, over 32% of open-end mutual funds experienced a manager change in any given year between 2006 and 2010.
Even if the new manager has a proven track record, there is no guarantee the fund will prosper. A new manager often brings a change in style, and investors should see if that style still fits with their investment plans, Schatsky says. When the person at the helm goes away, you should reassess your investment.
To stay clued in to turnovers, investors should read the company s prospectus reports or ask a broker.
5. I like to look busy.
In most cases, when investing for the long run, money managers should trade stocks and other investments infrequently. Instead, they sometimes focus on the short-term outlook, and that results in high turnover.
The average turnover for domestic equity funds is 103% within a year, according to Morningstar. High turnover creates transaction costs, which ultimately increases fund's expenses. With investments that are outside of retirement accounts, high turnover leads to tax inefficiency because each time a turnover occurs, the investors realize gains or losses, Schatsky says. Those gains are often better served being reinvested than cashed out. There will be numerous helpful capital gains recognized regularly and many might be short term, he says. Frequently people will like to have gains deferred and have them grow in fund itself.
6. Take a closer look at your mutual fund s board of directors.
Corporate boards attract plenty of attention. Investors want to know what they make, how much they pay company executives, and how they re protecting stockholders from fraud. Mutual fund boards receive much less public scrutiny, yet in many cases, they wield as much power and influence.
That could lead to a lack of board oversight, says Mercer Bullard, president of shareholders rights group Fund Democracy.
A few years ago, the Securities and Exchange Commission tried to tighten rules governing who could serve as a mutual fund director. The SEC sought to mandate that about 75% of directors be unaffiliated or independent from the mutual fund company. The effort was unsuccessful, and today the minimum requirement remains 40%. Many mutual fund boards surpass that percentage, says a spokesman at the Investment Company Institute, a national association of U.S. investment companies, including mutual funds. Something like 90% of funds boards are already more than 75% independent, he says. They ve arrived at where the SEC wanted to take them.
7. I ve got way too much on my plate.
Obviously, money managers aren t just looking to make money for investors. Their pay is affected not only by their performance and experience, but also by the amount of money they manage. In some cases, it may be in a manager s financial best interest to take on more assets than he or she can handle and performance could suffer.
To avoid getting short-changed by an overwhelmed fund manager, try to find out how many portfolios separate accounts your manager runs. In most cases, investors can do this by asking the middleman, their financial advisor, who usually serves as the sole way to access the money manager. The advisor works on behalf of the investors to help make that determination, of whether the manager will be a good fit, says Christopher Davis, president at the Money Management Institute. To make that decision, the financial advisor will consider your investment objectives, your financial plan and your risk levels.
8. Managed accounts are a terrific investment for me.
Managed accounts have become increasingly popular investments in recent years. Total assets in these accounts grew from $1.1 trillion during the second quarter of 2006 to $1.77 trillion during the second quarter of 2010, according to MMI. However, it remains unclear whether these accounts offer investors as much value as they offer the managers running them.
Like mutual funds, managed accounts are professionally managed portfolios with specific investing objectives. Unlike with mutual funds, investors actually own the stocks in the portfolio, so they won t owe capital gains taxes unless they sell those stocks. However, a customized portfolio doesn t always come with a lot of personal attention from the manager. Denise Farkas, chief investment officer of Sigma Investment Counselors in Michigan, says managed accounts often rely on computers to construct a model portfolio and duplicate a manager s moves in dozens, even thousands, of accounts.
Compensation to money managers working with managed accounts is in the range of 0.35% to 0.85%, depending on the investment style, with equities strategies at the higher end, says Davis.
9. I m as susceptible to a good scam as anyone.
Is a personal money manager better to work with than a stockbroker? Brokers earn commissions on everything they sell you, which critics say prompts them to push products. Some money managers charge a fixed percentage of your assets usually about 1% annually to manage them. Their goal is to find ways to increase your earnings and theirs.
However, although managers may not be churning their clients account, but they can still harm them with silly investments or fall prey to fraud. Investors should steer clear of investments they don t understand, says Schatsky. They should also consider setting up a separate custodial account, which gives them more control over their money and an increased level of comfort, he says.
To check up on a money manager, investors can contact their state securities office to see if any claims have been filed against him or her. They should also ask the money manager to provide them with a copy of Form ADV, which breaks down how they re paid.
10. I rarely pay for my mistakes.
The Financial Industry Regulatory Authority, an independent regulator that handles complaints from investors, reported that there were 3,322 new arbitration claims year to date through July. In 2009, total new claims hit a five-year peak of 7,137, up from 4,982 in 2008. On a historical basis, there tends to be a spike in claims during periods of increased market volatility and downturns, a FINRA spokesman says.
Although not all investors will be satisfied with the results of a complaint, it s not always a dead end to seek arbitration. For instance, if a manager puts money in speculative investments when their client has clearly indicated they want only conservative products, the client may have a suitability claim. Tracy Pride Stoneman, a securities lawyer in Westcliffe, Colo., won a settlement for a client who had lost $300,000 after a manager invested in high-risk mortgage derivatives despite orders by her client to invest only in government bonds. To help your case against a money manager, keep detailed records of all transactions, including notes of phone conversations and in-person meetings, she says.