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Step Up Your Fund Manager Scrutiny

Terry Savage

Does your mutual fund manager have your best interests in mind? Are you paying too much in fund fees? Ask yourself those questions as you approach your year-end investment review.

The answers could be just as important to your financial success as your asset allocation and fund performance.

One fund-information provider can help with this issue. Morningstar offers a unique service that helps examine the alignment of fund manager interests with the interest of fund shareholders. The firm offers "stewardship grades" as part of its $135 annual premium membership plan.

These ratings, first introduced after the mutual fund scandals of 2003, got a big boost with a 2005 Securities and Exchange Commission requirement that mutual funds disclose fund manager compensation and incentives, as well as how much money they personally have invested in their fund.

Don Phillips, managing director of Morningstar, says that even if investors don't pay close attention to the fine print, "the very fact that the funds must disclose this information is forcing closer attention to these issues."

Phillips points out that in the 1990s, many fund managers were compensated on the basis of their amount of assets under management, not by performance. As a result, those managers focused on short-term performance reporting.

Being at the top of a widely reported quarterly performance list would attract "hot money" -- new assets coming into their fund, and a larger bonus for the manager. But that wasn't in the best interest of the long-term fund investor. Now, Phillips notes, more managers' incentives are based on rolling three-year performance records.

Mutual fund trustees also have faced closer scrutiny in recent years. Warren Buffett once derided them as "lap dogs" who were paid big bucks for attending meetings but who were not working on shareholders' behalf to reduce fees and costs. Now, trustees are in the spotlight, as not only their pay but their investment in the funds, and the contract renewal process for the advisory agreement with the funds, must all be disclosed.

Stewardship Scrutiny

Morningstar reviews more than 1,200 mutual funds each year, and the focus is on more than just manager incentives.

The Stewardship grades, which range from A to F, are based on issues such as the level of fees compared with those of funds of like size and kind; the absence of regulatory issues; the "corporate culture" of the fund family and whether it encourages talent retention; and on the caliber of the board of trustees, as measured by factors such as independence, fund investments and how many funds each trustee oversees.

Phillips says that the ratings, which frequently include meetings with trustees, generate "a lot of discussion" -- and result in giving investors a voice and an impact, other than just selling their fund shares.

If you find your fund has a failing grade, it's time to examine why you're holding an investment that isn't doing its best for you.

Of course, sometimes fund shareholders can't just "walk away" and sell their shares because they're held in a company's 401(k) plan. And sometimes -- especially in smaller companies -- those funds have huge (and unnecessary) annual fees and costs that detract from long-term investment results.

If you think your company plan isn't competitive, ask your boss or the human resources department to go to PlanSponsor.com, which provides information on pension and retirement issues. On the right column of the home page there's a place to click to search for an accredited PlanSponsor retirement professional in your area. This adviser will help your company benchmark its plan costs and services and start a search for a better, less costly provider.

Finally, when you get your year-end investment statements, don't just file them away. Grading your own performance is more difficult than complaining about your fund manager. But this is the time to face reality, and if necessary, to regroup and take a wiser course for next year.

You can do it if you'll take the time and effort. And that's The Savage Truth.