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Seeking Professional Money Management? Beware of Mutual Funds

“I think those who invest in mutual funds want someone else to do the thinking for them. But the fact that they can move the money around the family of mutual funds just through a phone call lets them feel that they can play tycoons.”

- Ron Chernow

It happened towards the end of the summer in 2013. My very pregnant wife and I decided to pack-up our bags and say good-bye to Tokyo. We had grown to love Japan, the culture, our diverse group of friends and the ex-pat lifestyle. But, after almost five years as an international assignee, employed as a government bond and interest rate derivatives trader with the Royal Bank of Scotland, it was time to transition along to the next phase of our lives.

We moved back home to the San Francisco Bay Area, about two months before our daughter Sascha was born, and decided to settle in Marin County. Over the previous fourteen years, I had been living and working in both New York and Tokyo and frequently longed for the outdoors, fresh air, and Mediterranean climate. Marin fit the bill perfectly.

Before all this, we had the misfortune of being delayed in starting our family. My wife and I hit some road blocks along the way to her full-term pregnancy, which to say the least was rough for us both at times. Understandably, many couples do not like to discuss how difficult it can be emotionally when struggling to conceive. We had our ups and downs during this period, but we were also very fortunate to have supportive families and friends in our lives. In the end, we prevailed and then became determined to not allow the pleasure of early childhood rearing pass us by. Without a doubt, the highlight of my life thus far has been raising our daughter, together with my wife over these past five years.

After Sascha was born, we both took the next year off from our careers to focus on bonding and parenting. Later, my wife went back to work as an apparel designer (this time transitioning from women’s wear to the kids’ market), while I struggled to figure out my next step. I did not want to go back to working as a trader for the big banks, as towards the end of my career I became a bit disillusioned as to my purpose. Where was this all headed I thought? Am I learning anything new? Who am I helping? Outside of PnL’s , can any of what I do be measured?

After a few discussions with my father, I decided to go for it and start Pacificus Capital Management. A firm that would focus mainly on managing the wealth of individuals and families. We would not allow any conflicts of interest with our clients to arise nor employ proprietary products such as in-house mutual funds. We would work as discretionary, fee-based, separate account investment managers and advisers. As IAR’s (Investment Adviser Representatives) we would adhere to a fiduciary code of duty. The needs of our clients would always be put first and before any profits. This was the way it had to be.

It has been a few years now into the growth of my firm and I have one specific observation I would like pass along. Aside from the smallest investors who tend to be relatively young and just starting out, employing an investment strategy that either exclusively or heavily utilizes mutual funds as the investment vehicle of choice is usually inferior to investing with a separate account manager, who manages client portfolios made up of individual stocks, bonds and exchange traded funds. Here is why.

  • Inability to Personalize – A mutual fund is an investment vehicle which pools together many investors assets. In order for this to work well, each investors’ return objectives and risk tolerance should be similar. This is unlikely to ever be the case. Factors such as investment time horizon, allocation preferences, ethical considerations, tax situations, concentrated investment positions, liquidity and income needs can vary widely between investors. Mutual funds are a generic, one size fits all investment vehicle.

  • High Fees or Complex Costs – Typically a separate account investment manager/adviser charges somewhere in the ballpark of 1% of assets under management. However, in addition to this charge the mutual fund company/manager must also be paid as well. Mutual fund expense ratios can be as little as a couple of basis points but as high as a couple of percentage points and include management fees, 12b-1 fees (marketing), administrative fees, and operating costs. Additionally, many mutual funds have high trading turnover within their portfolios, which can mean investors are paying implicitly more in both trading commissions and bid/offer spreads. Personal Capital, a robo-advisor firm published a table of estimated charges by large institutions, which was then re-published in Financial Advisor IQ here. Simply put, if you are paying an investment advisory fee of 1% to a separate account manager and additionally paying a mutual fund expense ratio of 1% then you are paying at least 2% away in fees annually for the management of your investment portfolio. This is the amount an investor’s investment needs to return every year before he/she will begin to profit. The question an investor should ask – why am I paying double for an investment manager/adviser to simply pick mutual funds for me?

  • Tax Disadvantage – Mutual funds have certain tax disadvantages that negatively impact returns. Similar to individual securities such as stocks and bonds, profits in mutual funds are subject to capital gains tax. However, with mutual funds an investor will be held accountable for any capital gains the fund has throughout the year. As an investor, you have no control over when or what the fund sells or when it distributes these capital gains to you. For example, a mutual fund could have purchased shares in a company many years ago whose stock then increased in value. A new investor may have bought into the mutual fund after the gains in the stock occurred and therefore not received any of the benefit of the share price increase. However, when the fund goes to sell those shares, all current investors will be subject to the full amount of capital gains tax – whether or not the investor profited from the past purchase of those shares. Additionally, mutual fund capital gains can be incurred as the result of investor redemption requests, as the portfolio manager running the fund may need to sell securities to cover these sales requests. Also, because capital gains in a mutual fund are distributed to the shareholders of the fund, an investor could end up paying taxes on gains in a year where he/she didn’t sell any shares themselves or even worse when the overall fund had a losing year. In other words, an investor can lose money in a mutual fund and still have to pay taxes. This is what happened to many mutual fund investors this past year in 2018.

  • Poor Communication – Investors in mutual funds should not expect to communicate directly into the fund investment management team. Instead, investors will be assigned a sales representative whose main objective is to sell more mutual funds, not manage investments. Mutual funds can have thousands of shareholders, which makes communicating directly with a portfolio manager pretty much impossible. Investors who have questions about strategy and or portfolio changes will be unable to speak with anyone but a sales representative. Additionally, it is unlikely a mutual fund manager or sales representative will contact investors to see if their investment objectives have changed and if that particular mutual fund still fits their circumstances.

A message to prospective clients – if you possess financial assets of $100,000 or more that sit in an old company 401K plan, a brokerage account in which you pay sales commissions, or with an adviser that exclusively picks mutual funds instead of managing an investment portfolio, it may be time to move on to an investment strategy employed by a manager/adviser that is superior and will better serve your needs. In these uncertain times, it has never made more sense to seek professional advice in planning your financial future, but it is important that the advice you receive is for your benefit, rather than your adviser’s. There is never a charge to speak to us about our services. Please contact me to find out more and to see if we’d be a good fit.

***** On financial markets, I am still constructive overall. Although, I do believe we are in the final innings of an economic expansion, investment returns this year will likely be respectable. I see the 2018 fourth quarter decline of -20%+ in the US equity indexes as more of a correction rather than the beginning of a bear market. Similar to the late 1990’s, I wouldn’t be surprised to see this bull market end with more of an exponential blow-off top rather than what we witnessed throughout 2018. With the Fed doing a 180 degree move regarding monetary policy and communicating a more dovish message to financial markets, my base case for 2019 is to see both equites and fixed income to broadly produce positive returns. Nevertheless, GDP growth and corporate profits appear to be decelerating, while inflation (a typical lagging indicator) will likely follow suit. As a result, portfolio equity exposure for the time being will remain, at or just below client target allocations, while bond hedges and income producing assets will continue to play an important role in achieving long term objectives.


Justin Kobe, CFA Founder & Portfolio Manager


Advisory services through Cambridge Investment Research Advisors, Inc., a Registered Investment Adviser. Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a broker-dealer, member FINRA/SIPC. Cambridge and Pacificus Capital Management are not affiliated.Material discussed is meant for general illustration and/or informational purposes only, and it is not to be construed as investment, tax, or legal advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon when coordinated with individual professional advice. These are the opinions of Justin Kobe and not necessarily those of Cambridge Investment Research, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Investing in the bond marketis subject to risks, including market, interest rate, issuer credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies is impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Diversification and asset allocation strategies do not assure profit or protect against loss.

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