Brent Sheather: A closer look at fund manager tricks

Fund managers have a range of tricks up their sleeves to help present their products in a better light. Photo / Thinkstock

The advent of the FMA, ethical and academic standards for advisers and the subsequent exit, some via the courts, of a few dodgy fund managers and financial advisers' has meant a fundamental improvement in the playing field for retail investors.

In light of these improvements perhaps even those cynical individuals who in the past have eschewed the stockmarket and invested in residential property might be inclined to give the idea of abdicating the management of one's savings to someone else another chance. There is some obvious merit in this line of thinking, not least of which is the free lunch of risk reduction via diversification that managed funds offer.

However it is today still possible in NZ for financial advisers to ostensibly put their clients interest first but at the same time sell an investment plan in which fees consume 48 per cent of the income produced. Whilst this might be legal my guess is that the average Mum and Dad will not regard it as satisfactory.

It is also hard to reconcile fees of this level with the FMA's Statement Of Intent whereby the FMA hopes to achieve "efficiency" in financial markets. Fees at this level substantially detract from the efficient allocation of capital and are probably a good reason why residential property is so popular despite being far more expensive in terms of earnings yield.

This week we take a closer look at a few of the tricks fund managers still have up their sleeve and can and do use to present their products in a better light than would otherwise be the case.

Two areas where fund managers score badly is the process of benchmarking and, as usual, the disclosure of fees. Benchmarking is the process of drawing a graph or chart to show how well your managed fund has done relative to something else. Intuitively one might expect that this benchmark should be relevant to what's in the managed fund. Common sense.

For example a managed fund investing in NZ shares would be compared with a common measure of the NZ stockmarket like the NZX 50 Index. Alas that is not the case in NZ - a fund manager can pick whatever benchmark he or she likes and they often do because the best way to look tall is to stand beside a short person. Benefits are not just limited to marketing - benchmarks are increasingly used to determine performance fees.

So if you misrepresent your benchmark and compare for example your risky share fund's performance to a low risk fixed interest benchmark unit holders can end up forking out millions of dollars in performance fees. We highlighted this ridiculous situation back in August 2008 based on a report from a UK accounting firm and took a bit of stick from local fund managers for our trouble.

However it is very encouraging to see that the FMA has recently announced that it will look closely at performance fees payable on KiwiSaver products to see if they are reasonable ie that the benchmark reflects the portfolio of the fund.

Despite the changes the present investment environment for retail investors is still not up to scratch. We might have won the Rugby but in Rugby World Cup terms the NZ environment for investing via managed funds ranks with Namibia and Russia.

A recent report by Morningstar which looked at the investment conditions for managed fund investors around the world rated each country on a scale of A to F and unfortunately NZ got a D-. The Financial Times reports that "New Zealand was found to be the bottom of the class" and the report also said "NZ scored the worst overall largely because of low grades in the area of disclosure for prospectuses and shareholder reports".

Let's take a look at a real life example of the related issues of benchmarking and the disclosure of costs.

This table is from the website of a large NZ fund manager. The share fund has beaten the NZX 50 Index over three years and by more than 2 per cent over five years.

But hold on a minute before you write out that cheque - a glance at the factsheet says that the share fund actually invested in NZ and Australian shares with the latter being able to represent up to 50 per cent of the fund. This is perhaps a case of comparing apples with oranges.

Maybe the longer term outperformance of the NZX by the fund was not due to superior management skills but simply due to the better performance of the Australian stockmarket over the period. Secondly a note to the performance table on their factsheet says that the performance is before fees.

Is this significant? You wouldn't know from the managed fund's factsheet because it doesn't tell you what the fees are. To find this out you are referred to the 64 page investment statement and even here you don't get the full story.

A management fee of 1.0 per cent pa is disclosed plus "all expenses incurred in the operation of the fund will be met fully by the Fund". How much do all other expenses add up to? Who knows? But it gets worse - there is also a performance fee and, goodness me it uses the NZ 50 as the benchmark index even though the fund can invest half its money in Australia. If the NZ dollar depreciates against the Australian dollar that would trigger a performance fee payment? Ridiculous.

So is there anywhere in this enlightened age where the poor unitholder of this fund can see what they are paying their fund manager? The short answer is no but if you want more information, you are financially literate and have the time you need to go to a third document - the financial accounts of the fund.

You then need to do a whole lot of calculations and this will give you a closer idea of your annual fees but you still aren't told how much the fund spends on brokerage trading its portfolio.

But again the FMA is on the job, a few months ago our watch dog issued guidance for investment statements focusing on "concise, effective and clear information". Bring it on.