Wednesday, April 4, 2012
Expenses Matter and Investment Expertise is as Rare as Blue Diamonds
This radio personality occasionally mentioned a set of mutual funds she ran. I was able to locate them on Morningstar and get some raw information on expenses and performance. Boy was I surprised! These funds carried a 5.75% load. Ouch! They also levied 1.75 yearly expense ratio. So just to break even on the initial investment, the funds would have to return 8.1%. But wait..... that is not all. These funds were actually funds of funds investing in ETFs which incurred their own expenses. The ETF expenses ranged from a low of .40% to a high of .95%. So the effective expense rate of these funds is really around 2.25-2.45%.
But wait...... that's not all. To compensate for this kind of expense structure, these funds should be shooting the lights out on performance, right? Though heavily weighted toward commodities with precious metals ETFs and oil futures ETFs, not to mention shorting the S&P 500 while going long on the Peru and Vietnam stock markets, a $10,000 investment in these funds at inception (approximately a year ago) is now worth in the neighborhood of $7,000, falling quite short of the benchmarks. In fact, in the Morningstar performance rankings they consistently scored in the high 90's when compared to their peer group (1 is the best score, 99 the worst).
The moral of this story is quite simple: don't mistake confidence for competence. Anyone with money can buy their way into a weekend AM radio show. True investment talent is a rare commodity and takes many years to confirm. Most investment folks on the radio are sales people, not investment geniuses. Investment geniuses would be busy investing the money that keeps rolling in due to their successes, not trolling for new dollars from anonymous people listening on the airwaves. These funds may someday catch up with market returns, but they've set a high hurdled to overcome with their expense structure. The smart investor knows that expense ratios are the most reliable predictor of future results.