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Choose mutual fund managers who must eat their own cooking

by Wayne Cheveldayoff, 2003-10-26


Think of mutual fund managers as restaurant chefs, setting out to prepare great meals for investors in the form of spectacular portfolio returns. What would you think if these Ďchefsí do not eat their own cooking?

While some Canadian mutual fund managers are required to invest only in the portfolios they manage, most are not. Rather, they can invest in anything they want, and some mutual fund companies deliberately allow this because they feel it helps retain staff.

Unfortunately for investors, stories are often told by institutional equity salespeople about their clients, equity mutual fund managers, spending most of each morning trading their own account before eventually getting around to doing what you pay them to doóthat is, manage the mutual fund you have invested in.

This type of neglect could mean missed opportunities, or unnecessary losses, for the mutual fund portfolio and therefore for unitholders.

Take, for example, a situation where a company makes an announcement before the stock market opens. The opportunity to profit on that announcement is immediately when trading begins, not hours later. If the fund manager is busy with other things, the fund loses out.

Consider it from another perspective. U.S. mutual fund companies recently were found to have allowed large hedge funds to profit unfairly (and perhaps fraudulently) from late trading at the expense of the mutual funds they managed. It was a win-lose situation. The profit being extracted by the hedge funds was a direct loss to other mutual fund unitholders.

Would these mutual fund companies and their managers have allowed this to happen if their own money was tied up in those mutual funds?

One canít say it doesnít happen in Canada. A Canadian insurance company a few years ago found similar late-trading abuse by its employees. All funds are now reviewing their practices and it remains to be seen whether additional such cases may surface here.

For investors, the best protection lies in making sure the interests of the portfolio managers are perfectly aligned with the interests of the people they are supposed to be serving.

In other words, mutual fund managers should be required to eat their own cooking if they expect their customers to eat it.

And investors should choose only mutual funds where the managers cannot invest outside of the funds they manage.

In Canada, a few mutual fund firms have adopted such a policy with their fund managers, but most have not. And it is difficult to know which havenít because they donít publicize it.

When Synergy Mutual Funds was formed five years ago, a selling point was that its managers were restricted to only invest in internally managed funds. They could not invest in individual stocks or bonds or mutual funds offered by other companies. However, it is unclear whether this policy has survived the takeover of Synergy in October by CI Funds.

Donít expect any help on this front from regulators, either in providing information or setting rules. As with much of government, the securities commissions only respond to crises or blatant abuses. Neglect on the part of a fund manager would be hard to detect or prove. Without a banner case of abuse in Canada, it likely will remain below the regulatory radar screen.

Rather, it is up to individual investors to ask questions of their advisors and mutual fund companies and insist on funds where the managerís interests are fully aligned with their own.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. He can be contacted at wcheveldayoff@yahoo.ca.

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©2003 Wayne Cheveldayoff