Taking action: Implementing your written investment plan. BITING THE BULLET part 4

8 Jan


On the other hand, a large influx of cash from new investors may force the same manager to invest even when the markets are soft to prevent a larger cash position from pulling down the overall performance of the portfolio.

Diversification: Most equity mutual funds hold 80 to 120 dif­ferent securities. In a separately managed stock portfolio, the number of securities is usually half that amount. For an investor who is comfortable with a bit more performance volatility in anticipation of greater returns, the more concentrated portfolio with fewer securities may be appropriate.

Tax deductibility of management fees: The management ex­penses and transaction costs incurred within a mutual fund can­not be deducted as an investment expense by the individual investor. These expenses are accounted for in calculating the net asset value of the fund. However, outside of a registered re­tirement savings plan (RRSP), individuals can claim the fees paid to a money manager of a separately managed account as part of their miscellaneous investment expense deductions. Brokerage expenses: Mutual fund expense ratios, often referred to as management expense ratios, do not include the brokerage costs incurred to buy and sell securities in and out of the fund, nor do they include custodial fees charged by the trust company who acts as custodian of the fund. It is not uncommon for a mu­tual fund to generate significant transaction costs by turning over an entire portfolio frequently. In addition, the trading ac­tivity from ongoing new contributions and redemptions adds to brokerage expenses. All things considered, the total costs shouldered by investors in any given mutual fund can be very similar to those of a separately managed account. Shareholder information provided: Investors with separately managed accounts receive annual and quarterly reports from the companies in which they hold shares unless they opt not to. This is appealing to investors who want to understand the stock analysis and selection process followed by the money manager to whom they have delegated their buy and sell decisions.

Mutual fund unit holders receive annual and quarterly re­ports detailing the security positions held by the fund. Typically though, very little information is provided about the specific companies whose stocks are held in the fund, their products and services or their financial situation.

Specific identification of securities: Even though, with professionally managed separate accounts, investors are freed of the day to day buy and sell decisions, they are still informed of every transaction executed on their behalf. This is typically done by providing either a confirmation slip for every trade or a monthly custodial statement showing every transaction. The investor knows exactly what securities are in the portfolio. With a mutual fund, the shareholder receives less frequent re­ports showing total fund holdings.

Control over asset allocation: Because separately managed portfolios can be examined on a daily basis, it is relatively easy to monitor the manager’s commitment to appropriate asset classes. By the same token, it is not unusual for mutual funds to drift from their perceived mandate, such as when equity mutual funds hold relatively high percentages of cash or when a per­ceived domestic equity or balanced fund holds international se­curities. The mutual fund manager may be betting his fund assets on market segments not previously used but permissible under the prospectus. Again, manager discretion may be overly broad in a mutual fund setting but more easily controlled in a separately managed account.

Fees and compensation: Often one of the most compelling rea­sons for high income investors with taxable investment ac­counts (those that are not RRSPs) to choose separate account portfolios over pooled or mutual fund portfolios is the desire to deduct portfolio management fees as an investment expense on income tax returns. With mutual funds, these fees are not tax deductible because they cannot be paid separately by each in­vestor; they are incurred at the fund level, not the investor level.

Also, employment contracts for mutual fund managers tend to be structured so that the manager is provided with a bonus for outperforming his or her peer group. While there is little oppo­sition to such an incentive, it may increase the temptation to take more risk or make major sector bets such as on technology stocks. Mutual fund managers are not required to disclose their exact holdings on an ongoing basis, and their portfolios can be shrouded in secrecy if they do not want competitors to know the fund’s holdings.
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