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ANALYSIS
March 2, 2009
Sagging Index no longer reflects what’s going on in the market, some say, Replacements? Google it, to start.
March 2, 2009
Downward price spiral will actually boost the cost of capital for most companies. CFOS, take note.
March 2, 2009
The latest bailout at AIG could be a preview of how the president will deal with Wall Street.
March 2, 2009
No corporate defaults. Big debt offerings. Percolating CP issuance. Things may be looking up in the capital markets.
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April 23, 2007 12:01 AM ET
HARDLY EQUITABLE Researcher Rob Bauer says mutual funds deliver below-market returns.
“The Performance of U.S. Pension Funds,” authored by Rob Bauer, professor of institutional investors at the University of Maastricht, Hubert Lum, research director at CEM Benchmarking, and University of Maastricht students Rik Frehan and Roger Otten, represents the first time that the cost difference between mutual funds’ and pension portfolios’ separate accounts in the U.S. has been translated into performance terms. These hidden agency costs raise concerns about using mutual funds in individual retirement programs, such as individual retirement accounts, said Keith Ambachtsheer, director of the Rotman International Centre for Pension Management at the University of Toronto. The research also generates concerns over the Bush administration’s now-shelved proposal to privatize Social Security, Mr. Ambachtsheer said. That proposal would allow individuals to invest a portion of their Social Security savings. Considering that neither U.S. defined benefit nor defined contribution plans were able to beat their benchmarks after costs, mutual fund investors are getting a return substantially below the market, said Mr. Bauer. He explained that only agency costs could explain the additional 1% of negative return mutual funds experienced after stripping out the 1.5% in upfront costs. Agency costs are charged in addition to upfront management fees and are incurred by intermediaries such as money managers, but passed onto investors. They often include “hidden” expenses such as portfolio turnover and trading charges. “The difference in observable fees between mutual funds and pension plans is well documented, but what is surprising is the hidden costs,” said Brett Hammond, senior managing director and chief investment strategist at TIAA-CREF, New York. Liquidity is often cited as a contributor to agency costs, but that “is not an explanation, as mutual funds charge [upfront] load fees to take account of liquidity costs,” said Mr. Bauer. The research did not look at the impact of load fees on performance. Often the same money manager that ran the mutual fund and the segregated portfolio for a pension fund would charge mutual fund investors substantially higher fees for the same product, said Mr. Bauer. “The differences between what directors of mutual funds charge their institutional and retail clients are staggering,” said John Bogle, founder and former CEO of Vanguard Group. Mr. Bogle is now president of the Bogle Financial Market Research Center. Mr. Bogle said Mr. Bauer’s research was in line with his expectations that mutual funds were far more expensive than pension funds and tended to underperform by around 250 basis points per year. “If you were to include sales fees, mutual fund performance would be even less,” he said. Portfolio turnover is also a major contributor to hidden costs in mutual funds and could cost the investor up to 90 basis points in performance, he added. Performance differences between mutual funds and pension funds were much smaller for passively managed portfolios in which the guidelines of the account are stricter than for other mandates, Mr. Bauer said. “With passive mandates there is less scope for agency costs,” he added. His research found the performance differential between passive portfolios managed for pension plans and mutual funds to be only 30 basis points per year. The widest performance differences between pension plans and mutual funds were for all actively managed and small-cap portfolios where mandate terms were looser. Agency costs are likely to be found in other asset classes such as venture capital, although the data showing how pension plans have performed in these asset classes is limited. Mr. Bauer is now investigating whether there is a performance differential between pension fund and mutual fund fixed-income portfolios. He expects his study to be completed by the end of the summer. The impact of agency costs on mutual fund bond funds should be less because fixed-income funds are managed in a more standardized way than equity portfolios and more extensively passively managed than equities, he said. But Mr. Bogle is confident that Mr. Bauer will find a similar pattern in fixed-income portfolios. “Three quarters of all bond funds carry a sales commission, they have an expense ratio of 1%, and if they are held for less than five years then the investor will face a transaction charge of around 25 basis points. So we are looking at around 225 basis points in fixed income,” said Mr. Bogle. —Pensions & Investments
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