Need to borrow for a car or home? Look out: Your bank could be a loan shark in disguise.
1. "You have more investing experience than I do."
Sounds simple: Look for an experienced stock jockey when choosing a mutual fund. Now, try and find one. Nearly half of all funds are run by managers with tenure of two years or less at that fund -- and their inexperience shows. Since 1997 only 43% of managers with less than five years on a fund beat the S&P 500; on the flip side, 62% of managers with 10-plus years beat the S&P.
The surplus of newly minted fund managers is a product of the late-1990s bull market. Fund companies scrambled to train talent and launch new funds, and those young turks were eager to build a name and then go solo. Consider Ryan Jacob. At age 28 he was running the Kinetics Internet fund, which averaged 206% gains in 1998 and 1999. Then he started his own asset management company, got $200 million from investors and took such a beating in the tech collapse -- a 95% plunge -- that the fund has ended up as the next-to-worst performer. But his youthful optimism remains. "You have to be able to survive a bear market to have any lasting power in the business," he concedes.
2. "I'll beat the market...someday."
Whether you're looking for a newbie or a graybeard, it's tough to find any manager who consistently beats the market these days. It's all too easy to find people who have failed. Not even a third of large-cap managers have outperformed the market over the past 10 years. And yet some just keep hanging around. Fred Reynolds, manager of Reynolds Blue Chip Growth, has produced only about 5% annually during the past 10 years. That doesn't even beat Treasurys. Heiko Thieme has done even worse. Since 1992 he has lost about 22% a year managing American Heritage; the S&P index is up 10% annually.
Such returns, says Mercer Bullard, who runs shareholders' rights group Fund Democracy, "make it tough to argue in favor of active management. Index funds are a better option." Perhaps. Or just dig deeper into a fund's record. Start by going to SmartMoney.com and the "Snapshot" and "Return" pages of the fund you're interested in. There, you can get results beyond the typical one-, three- and 10-year periods.
3. "I'll write fairy tales to boost your assets...and my fee."
Is a 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. On the other hand, money managers typically charge a fixed percentage of your assets -- usually about 1% annually -- to manage them. Their mission: to find ways to increase both your earnings and theirs.
Sounds legit, but heads up: Your manager may not be churning your account, but he can still harm it with silly investments. That's what happened to hundreds of investors who lost $35 million in Tampa Bay, Fla. A network of local money managers recommended bonds from Evergreen Securities and Worldwide Bond Partners that promised 10% annual yields if investors kept their money tied up for five years. The problem? The bonds were bogus. Evergreen's founders ended up pleading guilty to securities fraud in April.
You can check out a product your manager recommends by contacting the SEC or your state securities office to see if the product is registered. "If it's not, that's a red flag," says Michael Runyon, head of the Securities Fraud Task Force at Tampa's U.S. Attorney's office, which busted the Evergreen bond scheme.
4. "I've never really run a hedge fund before."
hedge funds have become an escape hatch to avoid crummy mutual fund managers. Assets in these funds, once reserved for the superrich, have nearly doubled over the past two years. One reason: Money managers are eager to start or join new ones because they offer better pay than traditional investment funds. Hedge fund managers earn 1 to 2% of assets and 20% of any portfolio gains annually.
Here's the flip side: Hedge funds are attracting some managers with little experience (and few scruples) in using the funds' sophisticated trading techniques, such as short selling and merger arbitrage. Since 2000, more than 10 hedge funds have been accused of misrepresenting their returns or strategies. "Hedge funds can be dangerous," says Tim Curtiss, COO at Wall Street Investor Relations, which advises companies' investor relations departments. "There are no regulators looking over (managers') shoulders." That may change. In May, SEC Chairman Harvey Pitt announced a formal investigation into hedge funds, citing concerns about conflicts of interest. The SEC is also said to be considering stricter reporting standards for hedge funds.
5. "Good luck finding out who's in charge."
When the market was hot and nearly every mutual fund was delivering solid gains, no one cared who was running their fund. But with the average stock mutual fund down 12% this year and more managers jumping ship, investors want to know who's at the helm.
Unfortunately, some fund companies are making that tough to learn. Safeco switched to team management for some funds in the past two years and often won't disclose managers' names for team-run funds. In December, Putnam Investments stopped identifying individual fund managers in reports to investors. In June it backtracked and said it would name portfolio "leaders" (in charge of buying and selling shares) in prospectuses, in semiannual reports and on the Web.
Fund companies say it's too costly to notify investors every time a manager changes, but critics scoff. "People have a right to know who's buying and selling the stocks in their fund and if the manager of their fund leaves," says Gary Schatsky, a financial adviser and lawyer in New York. A new manager often brings a change in style, and you should see if that still fits in with your investment plans. "When the person at the helm goes away," Schatsky says, "you should reassess your investment."
6. "I buy stocks for your account...and have no good reason why."
Stocks weren't created to be traded like baseball players in a rotisserie league. But try telling that to some managers. "A lot of managers trade through positions just to show they're doing something," says Bullard. "The high turnover is a symptom of a problem. Managers have short-term outlooks." He has a point. The average domestic stock fund flips through its holdings in less than a year, letting taxes eat into gains. Just look at RS MidCap Opportunities. At first glance, it appears manager John Wallace did a fine job beating the S&P the past five years. But Wallace trades four times as often as the typical domestic stock fund manager. Adjust his portfolio for taxes, and his gains become a loss of about 4% a year. "We do everything we can to minimize (taxes), but with market volatility, there's only so much we can do," says assistant manager Jay Sherwood.
7. "My directors are all asleep."
Garrett van wagoner delivered performance that dropped jaws during the late 1990s. Four of his five Van Wagoner funds gained more than 200% in 1999. Still, while the Nasdaq was dropping 39% in 2000, Van Wagoner's tech-heavy portfolio continued to invest sizably in so-called private placements (nonpublic companies) that his firm could value itself. It wasn't until 2001 that Van Wagoner dramatically reduced the prices of several positions, which hammered the funds' performances (four portfolios have lost more than 55% in the past year).
As it turns out, Van Wagoner was getting little oversight from his board of directors. Besides Van Wagoner's, there were only two other director seats -- including one that went vacant for roughly 12 months over the course of 2000 and 2001. That meant virtually no one was there to stick up for shareholders. "We have followed our policies to a T," says spokesman Peter Kris. "And these policies were set up by our auditor, lawyers and board."
While the Van Wagoner case is extreme, fund watchers say fund boards -- designed to spot-check managers' decisions -- too often act as rubber stamps. "Boards should ask tougher questions," says Jeff Kiel, a vice president at fund-tracking firm Lipper, adding that a more active board could have forced Van Wagoner to defend his pricing strategy.
8. "Managed accounts? Don't buy my hype."
In recent years money managers have had a new product to pitch customers: managed accounts. Their popularity is quite apparent. Assets in these accounts have more than doubled since 1996, rising to $413 billion as of the first quarter of 2002, according to the Money Management Institute. And yet for all their growing appeal, the question is, who really benefits from these accounts -- the investor or the money manager?
Like mutual funds, these accounts are professionally managed portfolios with specific investing objectives. Unlike mutual funds, you actually own the stocks in the portfolio, so you won't owe capital gains taxes unless you sell those stocks. But if you think a customized portfolio means you'll get a lot of personal attention from the manager, think again. Denise Farkas, a chartered financial analyst at Spero-Smith Investment Advisers in Cleveland, says managed accounts often rely on computers to construct a model portfolio and duplicate a manager's moves in dozens, even thousands, of accounts. Managers, on the other hand, get a nice boost by "overseeing" these funds. They earn 1.5 to 2% of assets per year, versus 1.3% for running a stock mutual fund.
9. "I've got a lot more on my mind than your account."
Obviously, fund managers aren't just looking to make money for investors. Their pay is affected not only by their performance and experience, but by the amount of money they manage. "It may be in a manager's economic best interest to take on more than he can handle," says Jon Zeschin, former president of the Founders mutual fund family, who now runs an investment advisory firm. And performance can suffer.
Consider Elise Baum. After a few good years running Merrill Lynch Mid Cap Value, she took over the Small Cap Value and Global Technology funds. Since then Mid Cap Value has fallen to the bottom quarter of its Morningstar group. "We do not believe a manager should deviate from a fund's investment strategy due to market volatility," says a Merrill Lynch spokeswoman. "One or two quarters is not an accurate measurement of overall performance." To avoid getting short-changed by an overwhelmed fund manager, ask the fund company how many portfolios -- mutual funds and separate accounts -- your manager runs. Also, find out how much money he runs in all those portfolios and how much is flowing into the fund you're interested in. You'll then have a better idea of how important your portfolio is to the manager.
10. "Just try to make me pay for my mistakes."
Amid all the market turmoil, stockbrokers have learned one thing: Beware the wrath of an angry investor. Through the first half of this year, the National Association of Securities Dealers reported record arbitration claims by investors against their brokers or brokerage firms. Too bad it's not so easy taking your frustrations out on a money manager. "Investors have very few options," says Joseph Borg, director of the Alabama Securities Commission.
Still, that doesn't mean you're totally at a loss. For instance, you may have a suitability claim if your manager puts money in speculative investments when you've clearly indicated you wanted only conservative products. Tracy Pride Stoneman, a securities lawyer in Colorado Springs, Colo., won a settlement for a client who'd 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, Stoneman recommends keeping detailed records of all your transactions, including notes of phone conversations and in-person meetings.