As far as fund managers leaving – I don’t think it matters whether a fund invests in public companies or private, you always run the risk of key people leaving. I doubt you will ever see a “forward looking statement” from a private equity fund indicating that their key manager will be jumping ship shortly.

Mike

Now, as far as investing in mutual funds vs other funds like hedge funds or private equity funds… There is no straight answer that one is definitively better than another. But my point is that PE funds show you in their GAAP cash flow statement exactly how much they are compensating themselves out of your fund. Do mutual funds do the same? Some do, some don’t, but my point is that they aren’t REQUIRED to do so. They only give you an MER % ratio (which may or may not include other fees) and they leave it up to you to calculate how much % of your cash that they are taking. Meanwhile, PE funds are run exactly like a business and are subject to the exact same GAAP accounting rules as any other business.

In the same manner, the PE fund is required to disclose such things as their balance sheet and many also provide forward-looking statements. Do mutual funds do that? No, not most of them – but they don’t have to, either. So, PE funds have to disclose everything and you can read it all before purchasing their fund. As an investor, we can read the quarterly reports and make our own informed decision before choosing to invest in the fund or not.

I know you’re a fan of indexing, so it probably never happens to you. But for me, many times in the past, I’ve invested in mutual funds and then within a few months, a new manager manager was hired who has taken the fund in a whole new direction that I didn’t like. And the part that bugged me was that there was no disclosure of any of this in any forward looking statements.

Phil: I wouldn’t call private equity compensation arrangements reasonable. After all, it’s the 2-and-20 crowd we are talking about. They earn their 2% whether they win or lose, so how is their compensation better than mutual funds? Also do you have any studies showing the average returns is better than publicly-traded equity? Do the average returns include those funds that flamed out? Also over what time period did they earn 15%-20%? Equity markets have returned as much over the past five years.

Preet: Comparing international equities to private equity is not reasonable. Adding international equities boosts portfolio returns and reduces risk. Can you make the same claim for private equity?

How you can NOT put private equity into your portfolio is beyond me. It is similar to the “diversify by increasing foreign content” argument that states Canada’s stock market represents only 3% of the world’s public equity – why limit yourself to 3% of the market?

Same philosophy – why limit yourself to 1/3 of the North American market?

I will have to start off by saying that I don’t have enough industry experience about how compensation is made to answer your direct question. But from my limited experience researching into it, I would have to say that a fixed fee-for-advice model would be the only one that would work within that ethical framework for a retail advisor business, but it wouldn’t really be feasible in the compensation side since the income would be sporadic. So, to answer your question, based upon my limited knowledge of the industry, is “no”.

Hence, I think the best balance may be found in a private equity fund sort of structure. You are correct that the performance fees when they exceed some benchmark (like the TSX composite) make mutual fund MERs pale in comparison. However, if they fail to exceed that benchmark, they make very little compensation – and if they continually fail to exceed that benchmark, then the fund gets whacked. As a result, they have to be very prudent and that is how these private equity managers earned the adage of being the “smart money”.

As I mentioned before, I am an investor in some of these funds. When I read some of these reports by some of the PE fund managers, some of the businesses in the portfolio earn them returns of over 100% per year when realized. Of course some of them barely break even or take a small loss on the transaction. It seems to me that the average fund return is somewhere in the 15-20% annual return range. And that is why I like to remain invested in some of these funds – it’s like a mutual fund of private companies often earning double digit annual returns. So does it bother me that they take a 25% performance fee on the amount of money that they make above the return on the S&P index? Not if they continue to give me the fund holder 15-20% a year!

Anyways, that’s just one man’s lonely opinion.

It turned out that many colleagues in the office are using an advisor they are all very happy with and she got a referral. The advisor charges 2% (inclusive of fees, commissions etc.) of assets but from what I can tell, my friend now has an asset allocation plan and has the basics set up right – like bonds within a RRSP or cash parked in a money market account or cashable GICs. I would argue that my friend made the right choice in going a professional advisor who knows his/her stuff. Yes, the advisor costs money but I’d say that she earns her fees and my friend knows exactly what she is paying and she can be the judge of the results.

I don’t think I am asking my question clealy enough so
I’ll try one last time –

Philosophically speaking…do you think it is possible to run a retail operation that adds value for clients, is financially feasible in terms of covering overhead and wages, and does an ethical job for clients?

Or do you feel it is impossible so everyone is doomed getting and paying for financial advice and even ethical advisors can’t possibly add suffient value to justify their cost.

For me, I’ve all but given up looking at getting into the retail brokerage side of the industry. Since then, I’ve been trying to figure out how to get into private equity instead – I am an investor in some private equity funds as well as asset management firms.

The private equity fund business model seems to make the most sense to me. Basically you buy shares of the fund and the team puts the money to work either buying equity (usually meaning a takeout of some business) or debt. So, all the investor is concerned about is the total return on investment… If the management firm takes too much money out of the fund or if the fund performs poorly, then the fund would probably get hammered in its share price.

So, the management firm is directly influenced by its fund’s performance, unlike some mutual fund that gets paid a 2% MER for holding onto shares of Royal Bank or something equally as ridiculous (meaning we can all do that in our brokerage accounts without paying an annual fee). And for mutual funds, it doesn’t matter if the fund does well or poorly, the manager continues to make their millions.