| #10 - Soft Dollar ExpensesThe reason a mutual | | | | junior analyst or two, in exchange for the fund's |
| fund exists is so small investors can pool their | | | | order flow at, say, 5 cents a share versus the |
| money, hire professional management, and attain | | | | normal 2 cents a share. The sell-side brokers get |
| diversity that would be nearly impossible for the | | | | fat commissions, the fund manager gets "stuff" |
| small investor by himself or herself. It would stand | | | | that would otherwise be paid out of his |
| to reason then that funds with hundreds of | | | | management fee. Everybody is happy...except for |
| millions, or even billions, would have economies of | | | | the shareholders who are footing the bill, and for |
| scale to demand from the street the most | | | | the most part, have no idea, that this is going on |
| competitive rates for trading their shares. Yet, as | | | | unless they read deep into the prospectus' fine |
| you will see, not only are fund firms NOT getting | | | | print.Why You Should CareThe Wall Street Journal |
| the most competitive rates, they are paying well | | | | investigated this practice and determined that, in |
| more than any individual can get through their | | | | 2002, $12 billion dollars were spent in soft dollar |
| discount broker.What are Soft Dollar | | | | arrangements, where $6.7 billion of this was an |
| Expenses?Hard dollars are expenses that come | | | | unnecessary mark-up from the sell side. Further, |
| out of a fund manager's management fee. These | | | | WSJ spotlighted several firms that were paying 5 |
| expenses include salaries for the fund managers, | | | | cents per share traded. That's $50 per 1,000 |
| analysts, and customer service people (yep, you | | | | shares. Now, consider that any individual can open |
| get dinged when you call that 800 line), the costs | | | | an account with a discount broker and pay less |
| of printing all those statements and other required | | | | than $10 for a comparable execution. The |
| literature, and all other office expenses associated | | | | wholesale rate for clearing these trades is |
| with running a fund. Oddly, very real expenses | | | | probably $1 for diligently-shopped execution |
| such as spreads and trading commissions are not | | | | services performed on an agency basis for a |
| included in the hard dollar tally, and show up only | | | | multi-billion dollar fund.The Investment Company |
| as a slightly decreased, barely perceptible | | | | Institute (the apologist association of Mutual Fund |
| decrease in annual performance. High friction in | | | | Management Firms) brushes off this practice by |
| these areas can amount to substantial costs over | | | | stating that all of the items received have value |
| the course of a year when you consider that a | | | | that the shareholders would have to pay anyway. |
| multi-billion dollar mutual fund trades billions and | | | | Maybe. But, these expenses should be coming out |
| billions of shares.Recognizing that decreasing a | | | | of the management fee. This practice masks |
| dollar of hard expenses for a fund manager | | | | hidden expenses that can be used by individuals |
| increases profit to their bottom line by a dollar, sell | | | | and their advisers when comparing one fund |
| side firms make arrangents with the fund | | | | versus another. The only reason to mask the |
| managers to provide everyday items in exchange | | | | true expenses is to hide the fact that the |
| for order flow at above-market costs. For | | | | managers are siphoning off more money from |
| example, a sell side brokerage firm provides | | | | investors than their fiduciary duty allows. In less |
| investment research (the value of which is itself in | | | | savory professions, this arrangement is called a |
| doubt), Bloomberg terminals, office space, even a | | | | kickback. |