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Dan's Reports
About Dan

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Fund industry's excesses
Excessive number of products requires scrutiny

If you had to guess how many investment funds were available for sale, what number would you pick? The latest data from Morningstar shows a grand total of 4,381 - including mutual funds, segregated funds, and some pooled funds. That's a staggering figure when you consider that there are a number of funds they simply don't track. We know why firms launch new funds (i.e. to make money) but I say the current trend of product consolidation among investment fund sponsors has a long way to go.

Marketing-driven product launches

The investment industry is very innovative. As soon as it figures out people want something, they deliver. When brokers realized many years ago that investors couldn't reinvest small coupon interest payments from conventional bonds, it "stripped" the interest coupons from the principal value, and sold them separately - thereby getting rid of the reinvestment problem.

In the mutual fund world, innovations like funds using index futures (i.e. TD U.S. RSP Index) and swaps (i.e. clone funds like Ivy RSP Foreign Equity) fed investors' hunger to exceed foreign content limits.

Most of the innovations are great, but sometimes the marketing departments get a little out of hand. Take investors' infatuation with investments that aim to pay out fat cash flows to investors as an example.

Some of the products are better than others. Based on my conversations with many industry people, I have reason to believe (not a known fact) that there have been more than a few instances where so-called "high income" funds were launched with monthly cash payouts set by marketing executives.

This makes no sense. It should be marketing departments asking the investment managers what target they think is feasible. But in a time where few funds are attracting new money, money managers are under pressure to assume mandates with which they aren't comfortable in many instances.

Hedge funds are another prime example. Firms that had never offered hedge funds in the past suddenly launched products because they're a growth area of the money management business.

Some firms have launched quality products by setting up the hedge fund and hiring an experienced manager (or team thereof) to actually manage the money. And then there are some that take the cheap route - take a money manager with lots of experience (though little or none of it in hedge funds) and tell her to start managing a long/short fund. However, this is the result of firms rushing products out the door while a certain segment is hot just to get a piece of the action.

In so doing, the industry has further confused its clients and tossed out a lot of inferior products for people to buy. Many investment products are nothing more than frogs dressed up like princes. Trouble is, investors don't figure this out until they bring the frog home.

I know I'm guilty of being labeled an industry cynic, but I truly believe there are lots of great investment products available for individuals. There are more than four thousand investment funds in Canada. Even if I said 90 per cent of them weren't worthy of your investment dollars; that would still leave a full 400 funds from which to choose.

Aside from criticizing the very industry from which I derive my living, the point of this article is to remind investors to look beyond an investment's packaging. I admit to being a skeptic, but a little skepticism is healthy because it triggers questions. With so many funds and other investment products for sale, many will not be worth a look.

The more you ask questions, the more you'll learn and empower yourself to sniff out some of the garbage.

Next week, I'll review some good, basic questions to ask when an investment is proposed to you.

Update on unitholder vote

Back in May, I wrote about a controversial proposal to raise mutual fund fees that Dynamic had tabled for a unitholder vote. I'm sad to say that the proposal passed. I can only guess that too few affected investors knew or understood the impact of passing the proposals. Investors must read voting information circulars so that they exercise their legal rights to vote on decisions that impact their money.

Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at dha@danhallett.com
 
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