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