Fee hogs that bring home the bacon

[DanH]

Fee hogs that bring home the bacon

Invest in these funds at your own risk. Heavy MERs are a burden that is likely to drag down a fund's returns over time, and there are hundreds of examples in the fund world. Still, high-achieving fee hogs are an intriguing form of fund industry exotica and, as such, they're worth examining.

...

What can investment advisers be thinking in putting client money into a fund that is the second largest in its category and yet has among the highest fees? No doubt, they're thinking about how the returns have easily justified those fees.

...

When a fee-hog fund outperforms its lower-fee peers, it pointedly raises the question of what should be more important to investors in choosing funds, smart managers or low fees?

Funds like AGF European Equity certainly make a case for buying the manager, and not the fee, but don't be fooled into basing your fund selection on this idea. A better suggestion: Find the smart managers running low-fee funds.

[George$]

Dan; I took a quick look at this same article this morning but when I saw that the data table only had one-year and 3-year data I decided it was not worth continuing. He is looking at "noise".
I'm sometimes disappointed in Carrick. But I suppose he has to make a living and that means writing a lot of copy.

(my two cents)

[yielder]

Fee hogs that bring home the bacon

Funds like AGF European Equity certainly make a case for buying the manager, and not the fee, but don't be fooled into basing your fund selection on this idea. A better suggestion: Find the smart managers running low-fee funds.

Looks like John Arnold's one of those John Neff type managers: "The investment objective of the fund is to provide long-term capital growth through shares of undervalued European equities. Fund managers use a disciplined, bottom-up value approach that targets stocks with a below-average price/earnings ratio and above-average dividend yield. Country allocation is a by-product of the location of attractive valuations. The fund 's market cap also reflects where attractive valuations can be found." (My emphasis.)

While I'm not surprised by the performance, I am impressed that he did it despite the 3% monkey on his back.

It's interesting to note that his return variability is greater than that of the benchmark.



But that's not surprsing since he seems to go where closet indexers aren't, i.e., financials don't dominate the portfolio.



As for "find[ing] the smart managers running low-fee funds", they don't exist in this category unless you opt for passive management. Using a minimum investment restriction of $25000 or less, active management starts at 2.35% and goes up. Most of the active performance in this category is pretty crappy: 75% of the funds do not beat the benchmark over 5 years; 86% underperform over 10 years; and 100% underperform over 15 years. And that's without adjusting for survivorship bias.

The problem is finding a John Arnold early. He might not surface within the first five years if those 5 years happen to be a growth dominated market à la dot.con. Maybe one starts with the investment objective. If it resembles AGF European Equity's, that's a flag. Execution of the objective is not a given though.

[Bylo Selhi]

the data table only had one-year and 3-year data I decided it was not worth continuing. He is looking at "noise".
I'm sometimes disappointed in Carrick.

Ditto. Especially since he has access to more compelling data in-house. A 10-year CAR of nearly 5% over index, after that 3% MER is impressive. (How much of that is skill, how much is luck and how much is attributable to a value tilt, etc. is as always open to fierce debate <duck> )

Added: I see that yielder added the multiyear performance data from Globefund that I linked to. A further question, how confident should we be that Globefund's MSCI Europe (CA$) numbers are accurate, e.g. represent total return?

[yielder]

(How much of that is skill, how much is luck and how much is attributable to a value tilt, etc. is as always open to fierce debate <duck> )

Source: Globeadvisor's ProStation Test Drive

I see that yielder added the multiyear performance data

A further question, how confident should we be that Globefund's MSCI Europe (CA$) numbers are accurate, e.g. represent total return?

MSCI produces returns in whatever currency you'd like. You questioning MSCI numbers?

[Taggart]

I don't really see how things have changed a great deal in the "active" mutual fund category, when long before anyone heard of the internet, funds like Templeton were charging a 3+ % MER, and 9% sales commission. It turned me off then, and it hasn't changed my attitude towards them now. Carrick got one thing right, "Fee Hogs".

[Bylo Selhi]

MSCI produces returns in whatever currency you'd like. You questioning MSCI numbers?

When an active fund beats the index by ~8% a year over 10 years I think it's prudent to ask simple questions like:
1. Are we using the correct index (i.e. MSCI Europe total return in CA$)? Globefund and their competitors have been known to make similar errors.
2. Are we using the correct index (i.e. is there an MSCI Europe Value index that better reflects the AGF's mandate)? We do know that the value slice of the TSX has greatly outperformed the TSX composite. Perhaps the same situation applies in Europe.

when long before anyone heard of the internet, funds like Templeton were charging a 3+ % MER, and 9% sales commission.

My Templeton prospectus from around 1992 indicates that Templeton Growth's MER was ~90bp. The crazy MERs came later when the fundcos switched to the DSC model and thus had to amortize the DSC and had to pay higher trailers in lieu of that 9% up front.

[Taggart]

when long before anyone heard of the internet, funds like Templeton were charging a 3+ % MER, and 9% sales commission.

My Templeton prospectus from around 1992 indicates that Templeton Growth's MER was ~90bp.

Bylo,

My memory is from ten years before your quote. Sorry, I can't prove it, but "that", I don't forget.

[yielder]

I think it's prudent to ask simple questions like:
1. Are we using the correct index (i.e. MSCI Europe total return in CA$)? Globefund and their competitors have been known to make similar errors.

I'll ask.

2. Are we using the correct index (i.e. is there an MSCI Europe Value index that better reflects the AGF's mandate)? We do know that the value slice of the TSX has greatly outperformed the TSX composite. Perhaps the same situation applies in Europe.

Data

[DanH]

Okay yielder. If you convince me that AGF European is no better than the value index, where can I buy this MSCI Europe Value index?

[brucecohen]

when long before anyone heard of the internet, funds like Templeton were charging a 3+ % MER, and 9% sales commission.

My Templeton prospectus from around 1992 indicates that Templeton Growth's MER was ~90bp.

Bylo,

My memory is from ten years before your quote. Sorry, I can't prove it, but "that", I don't forget.

I can validate's Bylo's statement. When Templeton Growth Fund carried a 9% FEL, the management fee was fairly low. Templeton then lagged other major fundcos in moving to the DSC structure with trailer and advisors began moving money out of TGF and into other funds. In the early '90s Templeton held a unitholders' vote on boosting the mgmt fee to enable them to adopt the same DSC schedule with trailer that other fundcos had. At that time*, the present value of the upfront DSC commission plus ongoing 0.50% trailer was akin to a 9% front end load BUT the FEL was paid out of pocket by the client while the DSC commish/trailer was paid indirectly through a higher mgmt fee.

* IIRC, the fundco models all assumed 10% annual return and 10% annual redemption rate. That was certainly the case for the Templeton 1994 limited partnership whose units and prospectus I still have.

[Bylo Selhi]

Okay yielder. If you convince me that AGF European is no better than the value index, where can I buy this MSCI Europe Value index?

That's a separate issue.

First, if we can establish that the fund essentially tracked that index, then it seems the manager added little "skill" above offsetting the MER, Globefund's impressive advantage over the plain MSCI Europe index notwithstanding. If one were to invest in this fund today there's no guarantee, or even much reason to suppose, that the manager will continue to perform as well in the next 10 years as he did in the past. Suddenly this fund doesn't look as great as it did earlier this morning.

Second, your question about where to buy an index fund or ETF that tracks MSCI Europe Value is a good one. Suppose you could buy such an index fund or ETF today for, say, 50bp MER. Now based on the numbers posted above and Carrick's column, would you buy that or the AGF fund? Why?

[Bylo Selhi]

the Templeton 1994 limited partnership whose units and prospectus I still have.

In case you want to compare notes I have hard copies of the TGF simplified prospectus dated 1Aug92 and for the rest of the Templeton funds dated 3Oct94. (I no longer own any of the funds.)

[Taggart]

I can validate's Bylo's statement.

I'm not questioning Bylo's statement. What I saw was in 1982, not 92. Anyhow since I can't prove it, I desist.

[parvus]

bylo wrote:

First, if we can establish that the fund essentially tracked that index, then it seems the manager added little "skill" to offset the MER, Globefund's 8% CAR notwithstanding. If one were to invest in this fund today there's no guarantee, or even much reason to suppose, that the manager will continue to perform as well in the next 10 years as he did in the past. Suddenly this fund doesn't look as great as it did earlier this morning.

Oh, I dunno. Is it skill, or is it execution? Like O'Shaughnessy, Arnold runs a concentrated portfolio defined by fairly strict rules:

Arnold is a dyed-in-the-wool value investor who practices what he calls a "30-30-30" value discipline. By that, he means the Dublin team's three key valuation criteria.

To be considered for the portfolio, a stock's current price must be at least 30% below its high over the past 18 months. Secondly, the stock's price-earnings ratio must be at least 30% below the market P/E (as long as the company still reports earnings).

The third key metric is dividend yield. To qualify for Arnold's portfolio, the stock's yield must be 30% above the market yield, and the company must be financially strong enough to continue paying dividends.

[DanH]

Okay yielder. If you convince me that AGF European is no better than the value index, where can I buy this MSCI Europe Value index?

That's a separate issue.

First, if we can establish that the fund essentially tracked that index, then it seems the manager added little "skill" above offsetting the MER, Globefund's impressive advantage over the plain MSCI Europe index notwithstanding. If one were to invest in this fund today there's no guarantee, or even much reason to suppose, that the manager will continue to perform as well in the next 10 years as he did in the past. Suddenly this fund doesn't look as great as it did earlier this morning.

First of all, look at the big dip in both indexes and look at what happened to AGF's much more concentrated portfolio. Greater company-specific risk, in theory, yet lower downside volatility. The theory has no explanation for this. Not that I'm a big quant guy, but at 8 percentage points per year over 12 years, I'd be willing to bet that the fund's information ratio would be statistically significant. And if I take some of your own words, one could also argue...

If one were to invest in this fund today there's no guarantee, or even much reason to suppose, that the manager won't outperform the index in the next 10 years as he did in the past.

Suppose you could buy such an index fund or ETF today for, say, 50bp MER. Now based on the numbers posted above and Carrick's column, would you buy that or the AGF fund? Why?

That's like asking: "What would you do if you won a billion dollars?". I don't want to deal in hypotheticals. Does the product exist - yes or no? If it doesn't, this is nothing more than an academic discussion because the best default option you can find is a broader MSCI Europe index fund/ETF.

[Taggart]

Okay yielder. If you convince me that AGF European is no better than the value index, where can I buy this MSCI Europe Value index?

That's a separate issue.

First, if we can establish that the fund essentially tracked that index, then it seems the manager added little "skill" above offsetting the MER, Globefund's impressive advantage over the plain MSCI Europe index notwithstanding. If one were to invest in this fund today there's no guarantee, or even much reason to suppose, that the manager will continue to perform as well in the next 10 years as he did in the past. Suddenly this fund doesn't look as great as it did earlier this morning.

Second, your question about where to buy an index fund or ETF that tracks MSCI Europe Value is a good one. Suppose you could buy such an index fund or ETF today for, say, 50bp MER. Now based on the numbers posted above and Carrick's column, would you buy that or the AGF fund? Why?

There's the WisdomTree Europe Total Dividend Fund (DEB). 48bp MER + broker commission. Not much of a performance history though.

[Bylo Selhi]

And if I take some of your own words, one could also argue... If one were to invest in this fund today there's no guarantee, or even much reason to suppose, that the manager won't outperform the index in the next 10 years as he did in the past.

Which boils down to the usual, "Will you be happy with the guarantee of just getting index-minus-MER returns or do you want to take a gamble that an active manager will (or won't) continue to outperform?"

I don't want to deal in hypotheticals.

Don't be too quick to dismiss the value of dealing with hypotheticals. A lot has been learned about a lot of important things when intelligent people "deal in hypotheticals."

Does the product exist - yes or no?

I'm not aware of such a product. But then again I don't know for sure if one exists (e.g. as a European-listed ETF)

If you want me to acknowledge that if (a) a properly diversified portfolio needs some European Value exposure and (b) the AGF fund has done a good job of proving that exposure even after allowing for fees, then yes, I agree that that fund might make a reasonable candidate for achieving such exposure. But considering that the "best" actively-managed European Value fund can't beat a "dumb" European Value index benchmark by a very wide margin then I'll also argue that there's a need for an indexed product, especially for those people who feel that investing is risky enough without further gambling that going forward the manager will continue to exhibit skill, will continue to be engaged by AGF, etc.

Added: Let me expand on the above a bit.

If people like Paul Samuelson had chosen not to "deal with hypotheticals" when they noticed how few actively-managed funds were able to beat market indexes, then perhaps we'd never have seen any index funds.

One of the current flavours du jour are so-called "guaranteed" investments. In effect the investor pays a premium (or sacrifices some return) in exchange for some guaranteed return. That return is always less than market return. Now when I see funds that outperform an index that are managed by disciplined (some might say "ideosyncratic") managers like Sarbit, Michael, Buffett, etc. the first thought that occurs to me is manager risk. Why? Because there's a (possibly considerable) risk that, even if the manager is demonstrably skilled, they may not be around to continue their winning ways going forward. And going forward is the only time period that any of us ought to be concerned with.

Thinking of "guaranteed" investments, while an index fund provides a guaranteed return of index-minus-MER, it also insulates investors from manager risk. In a sense, that preset return, with no chance of doing substantially better, is the cost of providing the guarantee. So, my "hypothetical" question to you Dan, is, "How much of a premium above index fund returns do you demand of an active manager to compensate you for the risk that he may not be able to do for you tomorrow what he did for others yesterday?"

[yielder]

Okay yielder. If you convince me that AGF European is no better than the value index, where can I buy this MSCI Europe Value index?

I'm not trying to convince anyone of anything here. The question was asked; I provided the answer.

The fund has a compound annual return of 15.0% with monthly price volatility of 4.4% vs 14.4% and 5.2% respectively for MSCI Europe Value Index.

[DenisD]

More grist for the mill. 10-year WisdomTree index backtest returns to September 30.

Code: Select all

WT Europe HighYielding 16.9%
MSCI Europe Value      13.8%
WT Europe Dividend     13.0%
MSCI Europe            10.7%


www.wisdomtreeindexes.com/index-details ... 0#backtest

www.wisdomtreeindexes.com/index-details ... 7#backtest

[DanH]

Which boils down to the usual, "Will you be happy with the guarantee of just getting index-minus-MER returns or do you want to take a gamble that an active manager will (or won't) continue to outperform?"

Is it fair to assume that the 'gamble' is the active manager? Is total return all that matters? What about risk-adjusted return (i.e. Sharpe)? How about downside risk exposure? What about forgetting about individual fund characteristics and focusing only on portfolio characteristics? Don't these things matter? Funny how index proponents rarely (if ever?) address these more practical issues in the active vs. passive debate.

If people like Paul Samuelson had chosen not to "deal with hypotheticals" when they noticed how few actively-managed funds were able to beat market indexes, then perhaps we'd never have seen any index funds.

I never said hypotheticals are worthless. Go back and read what I wrote, which was (with emphasis added): I don't want to deal in hypotheticals. I asked a simple 'yes' or 'no' question and you respond with a thesis that never actually answers the question.

One of the current flavours du jour are so-called "guaranteed" investments. In effect the investor pays a premium (or sacrifices some return) in exchange for some guaranteed return. That return is always less than market return. Now when I see funds that outperform an index that are managed by disciplined (some might say "ideosyncratic") managers like Sarbit, Michael, Buffett, etc. the first thought that occurs to me is manager risk. Why? Because there's a (possibly considerable) risk that, even if the manager is demonstrably skilled, they may not be around to continue their winning ways going forward. And going forward is the only time period that any of us ought to be concerned with.

Okay, but I dislike guaranteed investments and I do select managers in a forward looking context (i.e. try to focus on what matters going forward). So, I don't see how this is relevant in our discussion. It's not as if indexes are risk free. Isn't there a risk that indexes are poorly constructed? The free float issue comes to mind and the big change that happened with MSCI indexes (and funds tracking the same) 5 years ago.

Then there's the risk of choosing the 'right' or 'best' index - isn't that a risk? And then what about funds you've already purchased switching indexes? Barclays' change to more expensive currency neutral U.S. and EAFE indexes come to mind. So if you're a wealthy individual (enough to be afraid of U.S. estate taxes) who relied on those for exposure, you now have a choice between paying more (for other Canadian index funds), keeping the same iShares (and having your exposure change substantially), or roll the dice and buy U.S. ETFs and taking your chances with the IRS.

These sound like very material risks to me.

So, my "hypothetical" question to you Dan, is, "How much of a premium above index fund returns do you demand of an active manager to compensate you for the risk that he may not be able to do for you tomorrow what he did for others yesterday?"

Depends. Sometimes none. Back in 1998, we were placing Cundill Value in most of our portfolios. At that time, it was a chronic underperformer. Did the same with some Trimark products. Was it a risk? Sure. But so is walking out your door every day.

[DanH]

More grist for the mill. 10-year WisdomTree index backtest returns to September 30.

Code: Select all

WT Europe HighYielding 16.9%
MSCI Europe Value      13.8%
WT Europe Dividend     13.0%
MSCI Europe            10.7%


www.wisdomtreeindexes.com/index-details ... 0#backtest

www.wisdomtreeindexes.com/index-details ... 7#backtest

Back-tested numbers should be taken with a big grain of salt...or perhaps with the whole darn salt mine.

Hey Bylo, do you think it's a risk buying the WT Europe Dividend High Yield Index given its strong back-tested numbers?

I'm not trying to convince anyone of anything here. The question was asked; I provided the answer.

Yeah, I know. And all I did was ask you another question. But it's your choice to respond or not.

[Bylo Selhi]

Is it fair to assume that the 'gamble' is the active manager? Is total return all that matters? What about risk-adjusted return (i.e. Sharpe)? How about downside risk exposure? What about forgetting about individual fund characteristics and focusing only on portfolio characteristics? Don't these things matter? Funny how index proponents rarely (if ever?) address these more practical issues in the active vs. passive debate.

If you look at history, you'll (almost) always be able to find some actively-managed fund that beat its benchmark with less risk, etc. For me, the most important question though is will that fund/manager continue to outperform? Even if I concede that some people, including you, can identify superior managers, there's no way that anyone can foresee which ones will be around in 5, 10, 15 years or longer. That's a very significant risk. I don't see how that applies to an index fund.

It's not as if indexes are risk free. Isn't there a risk that indexes are poorly constructed? The free float issue comes to mind and the big change that happened with MSCI indexes (and funds tracking the same) 5 years ago.

The MSCI free float issue was resolved by MSCI without major pain to index fund investors. Even the "poorly constructed" TSX, when NT comprised 35% of market cap, has done well over time. Yes there are risks with some indexes, especially ones that track narrow slices. That's one reason why I prefer the broad, total market indexes. They may not be immune to construction problems, but their broad base protects them from all but the most serious earthquakes.

Barclays' change to more expensive currency neutral U.S. and EAFE indexes come to mind. So if you're a wealthy individual (enough to be afraid of U.S. estate taxes) who relied on those for exposure, you now have a choice between paying more (for other Canadian index funds), keeping the same iShares (and having your exposure change substantially), or roll the dice and buy U.S. ETFs and taking your chances with the IRS.

Because of their structure those BGI funds were mostly held in RRSPs so those who didn't approve of the mandate change could switch without tax consequence. If you have enough to worry about US estate tax you also qualify for CIBC's MER rebate. If you decide to switch to US ETFs then, again inside an RRSP, you have no US estate tax issues. So, at least with the example you gave, this is a non-issue Of course there's a risk with any index fund that its mandate could change materially or that it could be wound up, etc. Those risks, however, are extremely low for large US ETFs like VTI and EFA. I can't see how they can be comparable to active manager risk.

These sound like very material risks to me.

There are always risks. IMO the risk that a manager won't continue to run a fund and/or that a fund won't survive, etc. are far greater. Yes, even index funds and ETFs can die. TD's did, but there were warning signs from day one. One has to do some homework before buying blindly into any fund even those that track an index. When have I said otherwise?

Depends. Sometimes none. Back in 1998, we were placing Cundill Value in most of our portfolios. At that time, it was a chronic underperformer. Did the same with some Trimark products. Was it a risk? Sure.

Would you place the AGF European fund in that category? Would you use that fund as a proxy for the European equities part of a portfolio (i.e. without any other European equity exposure "tilt")? Would you even recommend that most investors slice and dice their overseas investments in this way? (Yes, I appreciate that there can be special situations when this might be appropriate for some small number of investors, but as a general strategy?)

I may have the fund confused, but wasn't it AGF's International Value an outperformer when Brandeis managed it? How's it doing now?

But so is walking out your door every day.

Now that is irrelevant

[Bylo Selhi]

Hey Bylo, do you think it's a risk buying the WT Europe Dividend High Yield Index given its strong back-tested numbers?

Yes. But not because it's an "index fund." That's completely irrelevant I'd consider it "risky" because, like you, I don't give a lot of weight to back-tested numbers.

[yielder]

where can I buy this MSCI Europe Value index?

Googling, this, this, and this.