Higher Fees Ahead

Ulli Uncategorized Contact

Last Monday, I wrote about a lawsuit that may potentially cut mutual fund expenses for investors. Now Vanguard is in the news signaling that higher fees may be on the horizon. Here are some highlights:

As if the market crash hasn’t been painful enough, more mutual-fund firms are set to raise their fees in response to falling assets, leaving shareholders with even less money in their battered accounts.

The decision by low-cost stalwart Vanguard Group to raise expense ratios for many of its mutual funds is a clear sign to investors of a tough year ahead.

After a brutal 2008, with many stock funds down more than 30%, fund investors face the prospect of paying higher charges this year as fund firms scramble to make up for lower asset levels.

Mutual-fund charges are based on a percentage of assets, but some of their costs — such as customer service centers and mailing out fund literature — are fixed. After the dramatic plunge over the past year, which has seen the industry’s total assets under management fall to $9.5 trillion from $12 trillion, hiking expense ratios is likely to be a viable option for many firms.

“It’s a testament to the market environment that even a fund family [like Vanguard] that’s been taking in new money has seen its assets decline so much that it has to raise its expense ratios,” said Dan Culloton, associate director of fund analysis at Morningstar Inc.

Vanguard said it had $84 billion in net inflows across all its funds in 2008, and $25 billion in net inflows so far this year. But according to Culloton, from the end of 2007 through the end of February, total assets under management fell to just below $1 trillion from $1.3 trillion.

So far, 31 of Vanguard’s roughly 110 funds have said they are increasing their expense ratios. The average increase is 0.05%; last year, Vanguard’s average expense ratio was 0.2% per fund.

Vanguard is “not immune” to the poor market conditions, said John Woerth, a company spokesman. But, he added, on a relative basis Vanguard is “still the low-cost leader by far.”

Sure, Vanguard is still the low cost leader, no question about that. However, cutting costs and reducing staff maybe a better option because many investors may not return, or those who do, may do so only on a temporary basis.

Why?

Vanguard is the staunchest supporter of buy-and-hold and, despite 2 bear markets during this century, they have not adjusted their model to support changing conditions. Despite this recent feel-good rally, we’re still stuck in the midst of the worst economic downturn since the 1930s.

We’ve seen a huge market drop last year devastating most investors’ portfolios. This was followed by a 20% rally from the November lows to the end of 2008. 2009 saw a 25% drop in the S&P; 500 within the first 7 weeks, and now a 23% rebound in only 13 trading days; who knows what’s next.

What this all comes down to is that we are in an investment climate which simply does not justify a mindless buy and hold solution. Many investors (I hope tens of millions) had to learn this sobering fact the hard way and will hopefully from here on forward use a more intelligent approach to managing their investments.

If they do, that will not bode well for the buy-and-hold shops as investors are no longer willing to get stuck with a bullish investment in a bear market and subsequently paying for the privilege of seeing their portfolios getting another severe haircut again.

No Load Fund/ETF Tracker updated through 3/26/2009

Ulli Uncategorized Contact

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

Up, up and away was the mantra as all major indexes gained for the third week in a row.

Our Trend Tracking Index (TTI) for domestic funds/ETFs remains below its trend line (red) by -5.14% thereby confirming the current bear market trend.



The international index now remains -11.39% below its own trend line, keeping us on the sidelines.

For more details, and the latest market commentary, as well as the updated No load Fund/ETF StatSheet, please see the above link.

From TARP To GARP

Ulli Uncategorized Contact



Much has been written about the various bailout packages more recently referred to as TARP (Troubled Asset Relief Program), which should now be renamed to GARP (Geithner Asset Relief Program).

Both have one thing common in that enormous amounts of money are being spent without any certainty that positive results can be achieved. My confidence level in these programs, which was almost non-existent to begin with, was pulled down another notch yesterday, when Treasury Secretary Geithner uttered the words before congress that “it only requires will; it’s not about ability.” Yeah right.

To really understand how these plans work, take a look at a humorous description as submitted by reader Tom:

Heidi is the proprietor of a bar in Berlin. In order to increase sales, she decides to allow her loyal customers – most of whom are unemployed alcoholics – to drink now but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans).

Word gets around and as a result increasing numbers of customers flood into Heidi’s bar. Taking advantage of her customers’ freedom from immediate payment constraints, Heidi increases her prices for wine and beer, the most-consumed beverages. Her sales volume increases massively. A young and dynamic customer service consultant at the local bank recognizes these customer debts as valuable future assets and increases Heidi’s borrowing limit.

He sees no reason for undue concern since he has the debts of the alcoholics as collateral. At the bank’s corporate headquarters, expert bankers transform these customer assets into DRINKBONDS, ALKBONDS and PUKEBONDS. These securities are then traded on markets worldwide. No one really understands what these abbreviations mean and how the securities are guaranteed. Nevertheless, as their prices continuously climb, the securities become top-selling items.

One day, although the prices are still climbing, a risk manager (subsequently of course fired due his negativity) of the bank decides that slowly the time has come to demand payment of the debts incurred by the drinkers at Heidi’s bar.

However they cannot pay back the debts. Heidi cannot fulfill her loan obligations and claims bankruptcy. DRINKBOND and ALKBOND drop in price by 95%. PUKEBOND performs better, stabilizing in price after dropping by 80%.

The suppliers of Heidi’s bar, having granted her generous payment due dates and having invested in the securities are faced with a new situation. Her wine supplier claims bankruptcy, her beer supplier is taken over by a competitor. The bank is saved by the Government following dramatic round-the-clock consultations by leaders from the governing political parties. The funds required for this purpose are obtained by a tax levied on the non-drinkers.

There you have it. A perfect explanation how a useless asset is being securitized and sold, large amounts of money are being made in the process and, ultimately, innocent bystanders are being asked to ante up via tax dollars.

Timing The Hedge

Ulli Uncategorized Contact

Several readers have emailed over the past few days requesting some details about the execution of the hedge trades.

The issue is when setting up the hedge by purchasing SH for the short side and mutual funds for the long side, which order do you place first on days when the markets rally sharply?

This certainly was the case on Monday as all major indexes shot into the stratosphere. On Monday morning, you could have placed your (long) mutual fund orders to be filled at that day’s ending prices.

But what about SH? Entering the order and getting it filled early or at mid-day would have exposed you to losses as the market rallied on.

I was caught in that exact position. Due to a prior commitment, I had to leave the office about an hour before the markets closed. At that point, the rally was on and the Dow was up some 300 points and rising. My plan had been to simply enter the short position as close to closing time as possible to limit any adverse price action.

Since that was not possible, I simply postponed any action and will enter my long and short positions on a day when I will be around at closing time.

I suggest you follow a similar pattern so that you don’t enhance the odds of starting your hedge with a slight loss.

Feeding The Bulls

Ulli Uncategorized Contact

Treasury Secretary Geithner fed the bulls yesterday by announcing the details of his latest plan to stimulate the financial system.

Much already has been written about it as the particulars are being dissected in any possible way.

The markets took this as a positive development and off the races we went with all major indexes gaining sharply.

As always, Mish at Global Economics provided some valuable insights as to this new spending plan in “Geithner’s Galling (and Dangerous) Plan For Bad Bank Assets.” If you’re not interested in all the gory details, here’s a summary about five misconceptions:

* The trouble with the economy is that the banks aren’t lending. The reality: The economy is in trouble because American consumers and businesses took on way too much debt and are now collapsing under the weight of it.
* The banks aren’t lending because their balance sheets are loaded with “bad assets” that the market has temporarily mispriced. The reality: The banks aren’t lending (much) because they have decided to stop making loans to people and companies who can’t pay them back.
* Bad assets are “bad” because the market doesn’t understand how much they are really worth. The reality: The bad assets are bad because they are worth less than the banks say they are.
* Once we get the “bad assets” off bank balance sheets, the banks will start lending again. The reality: The banks will remain cautious about lending, because the housing market and economy are still deteriorating. So they’ll sit there and say they are lending while waiting for the economy to bottom.
* Once the banks start lending, the economy will recover. The reality: American consumers still have debt coming out of their ears, and they’ll be working it off for years.

What it comes down to is that another $1 trillion or so will be poured down this bottomless sinkhole for which the next few generations get to pay as the taxpayers are on the hook for 93% of this plan’s obligations.

Since we do not any influence over the outcome, we have to focus on the effects as far as the market is concerned. Over the next few days, we will see if there will be any follow through to the upside or if this rally is limited in scope.

While our domestic Trend Tracking Index (TTI) is still 5.09% away from signaling a new Buy, we nevertheless have to be prepared to act should this trend continue. Entering via our hedge position is only the first step to gaining market exposure conservatively. We will become more aggressive once the trend line has been crossed to the upside.

Lower Mutual Fund Fees Ahead?

Ulli Uncategorized Contact

Another law suit is brewing as “Supreme Court could cut mutual fund expenses:”

The Court last week said it would hear a case brought against a mutual fund for charging investors too much, and some observers say the decision could set a new standard that will result in lower management fees.

At issue is how courts decide if a mutual-fund manager is charging too much for its services.

Since 1970, when Congress changed the law to allow so-called excessive fee lawsuits, investors have never won a case, though there have been some substantial out-of-court settlements.
…
What made the case stand out from other excessive fees cases was a spat it triggered between two of the nation’s most respected judges.

In May, Judge Frank Easterbrook ruled for Harris, saying in effect that fees can’t be considered excessive unless fraud was involved. The market, he argued, will ensure that fees aren’t too high because investors essentially will vote with their wallets and dump funds they consider unreasonably priced.

But Easterbrook’s colleague on the Seventh Circuit, Judge Richard Posner, wrote a scathing dissent of Easterbrook’s ruling. Posner argued that leaving fees purely to the market was flawed and called for a rehearing of the case, though his attempt failed.
…
Posner highlighted a factor that could be considered when judging whether a mutual fund fee is excessive: comparing it to what the fund manager charges institutional clients.

Posner pointed out that Harris charged Oakmark fund investors 1% on the first $2 billion of a fund’s assets. But institutional and other clients were charged roughly 0.5% for the first $500 million and roughly one-third of a percent for everything above. He said this pricing difference was of “particular concern.”
[Emphasis added]

Here you have two judges with opposing views. While I am in favor of lower fees, I believe that each mutual fund company should be able to set their own rates just like any business can charge for goods and services whatever the market allows.

Sliding fee schedules are standard procedure in the financial services industry and having a different set of numbers apply to (large volume) institutional investors compared to (small volume) retail investors seem reasonable as long as they are disclosed to everyone.

We are living in different times now. Only less than 10 years ago, as a mutual fund investor, you did not have the variety of low cost choices as we have now with the proliferation of some 700 ETFs. To me, the answer is simple. If you don’t like a fund for whatever reason (performance or fee structure), you can vote with your feet and go someplace else.

Having the courts decide what a fund company can charge under what circumstances means we’re walking down a very slippery slope with government interference when none is warranted.