What Your Fund Company Isn't Telling You
Excerpts from fund company earnings calls prove revealing.
Fund Spy
As we've often pointed out, a fund company has to serve two masters: the owners of the fund company itself, and the shareholders of the mutual funds it runs. And the interests of the two are at times in direct conflict. (This is the reason we're in favor of the SEC rule that would require fund boards to have independent chairs.) Higher management fees are good for fund company owners, for example, but bad for owners of the firm's mutual funds. Ditto for unchecked asset growth and the launch of gimmicky funds.
It's hard to spot these conflicts in the materials fund companies prepare for shareholders of their mutual funds. But fund companies' communications with their own stakeholders are often more revealing about their business motives. Here then are some recent excerpts that are particularly revealing from earnings conference calls conducted by publicly traded fund companies, along with our commentary on each.
Morgan Stanley, Fourth-Quarter Earnings Call | Dec. 20, 2005
What the fund company said: "Regarding performance, we're finishing the year just shy of our stated performance objectives. Forty-five percent of our assets are rated 4 and 5 star by Morningstar, and our 1-year, 3-year, 5-year and 10-year Lipper top-up percentages currently range from 61 to 83%. Our primary objective in this business is to shift our focus from profitability to growth and profitability with an emphasis on alternatives and the introduction of new, high-margin products."
Our Comment
Morgan Stanley says they're just missing their own performance objectives, but the vast majority of the firm's funds are rated 3 stars or lower. And so what is Morgan Stanley doing about this? Focusing on growth and profitability and "the introduction of new, high-margin products." That doesn't sound to me like it's gong to do much to improve performance for investors in most of the firm's funds, but it will improve Morgan's bottom line. After detailing their plans for new products, Morgan Stanley does go on to say, " . . . and of course, we will continue to focus on improving performance to the point where we are consistently at or above our longstanding performance objectives." Memo to Morgan Stanley: That should be your primary objective. Until you figure out how to run money effectively, forget the other stuff.
Eaton Vance, Fourth-Quarter Earnings Call | Nov. 22, 2005
What the fund company said: "As we have mentioned in prior calls, our focus on closed-end funds does redirect some of our sales and marketing efforts from our open-end funds. However, the very attractive financial characteristics of closed-end funds, low cost per dollar of assets raised, and lack of redemptions suggest to us that this is a very favorable and rational business trade-off. As you know, retaining assets is an important component of profitability in the asset-management business. One of Eaton Vance’s many strengths is our lower-than-average fund redemption rate."
Our Comment
Eaton Vance has been one of the leaders in the resurgence of closed-end funds in recent years. So why does the firm like the format? Because it's better for investors? Nope. Because investors can never redeem their money from closed-end funds, so the fund company can earn fees on the assets in perpetuity (investors can trade with each other over an exchange, but the original investment remains with the fund). Oh, and they're cheap to launch.
Federated Investors, Third Quarter Earnings Call | Oct. 28, 2005
What the fund company said (in response to a question about why the firm doesn't hire outside managers to run some of its poor-performing funds): "Well that is a challenge for us. We have done that before historically on the international side, and have found that when we did that it didn't sell as well inside the Federated distribution. There is an ethos, a culture, and an essence of who Federated is that has been communicated to our client base, and when we have tried to do that it simply hasn't worked as well as someone might have thought . . . So the subadvised route, although we've looked at some of those kinds of arrangements, we would much rather build them, and either build them or buy them and [own] them, and then if we're going to put the money in them, then the shareholders are going to be the owners and the ones who enjoy the distribution splendor that occurs at the end of that."
Our Comment
Part of the firm's response is that it's harder for the sales force to sell subadvised funds. That's fine, although one might ask why Federated isn't more interested in improving the prospects of the investors who are already in the funds. The last part makes Federated's motives clear: They don't want the fund to pay management fees to a firm outside the Federated umbrella.
Janus Capital, Third Quarter Earnings Call | Oct. 26, 2005
What the fund company said (in response to a question about the impact of performance fees on earnings): "I think it's fair to say that we looked at funds that we have a lot of confidence in, that we think are somewhat negatively correlated or lowly correlated with each other, and we wanted to make sure if one fund was working...or was not working, there would be another fund that would tend to work when that other fund wasn't working."
Our Comment
Janus is trying to right its ship after its funds burned investors badly in the bear market and it became embroiled in the market-timing scandal. In many respects, we've been pleased with what they've done. One initiative they've taken is to attach performance fees to some of their funds. We generally like performance fees, as we think they help align the management company's interests with those of fund shareholders. However, this makes it clear that Janus' goal was in part to ensure the negative and positive performance adjustments offset each other to a large extent, thus helping limit earnings volatility. If the firm really wanted to do the right thing, it would institute performance fees across its lineup.