By Brendan Wagner, Portfolio Manager
To begin, let’s start with some definitions:
And now a definition of a mutual fund:
As it relates to most people, mutual funds, exchange traded funds, and individual stocks and bonds are the instruments that make or lose them money over time. When one employs a financial advisor, the advisor becomes the portfolio manager, selecting the investment instruments most suitable for the clients’ goals.
Mutual funds can be useful, but inherently have an issue with taxes and capital gains. For example, a $5 billion dollar mutual fund might have 60% of their clients in non-taxable retirement accounts, and the other 40% in taxable accounts. So which client base does the mutual fund manager favor? Do they focus on minimizing capital gains for the nontaxable clients? Or do they trade more often and opportunistically, attempting to maximize total gains regardless of taxes, for the nontaxable accounts? With all clients shoved into the same vehicle, it is impossible to treat them differently based on taxes.
By contrast, a financial advisor managing portfolios can tailor investments and trading to suit each client. Also, if a client parts ways with a financial advisor, there is no impact on other clients. However, this may not be the case at a mutual fund. If a fund faces redemption requests of a significant level, it may be forced to sell securities in order to satisfy these redemptions. At times this can cause significant unwanted capital gains, even in down markets, for the fund’s other investors. Obviously, this is not a pleasant experience.
There can also be a problem with “timeframe,” as it relates to the portfolio management team at a mutual fund. There are many high-quality investment companies, and it is common for them to have the same investment team manage, for instance, a large pension fund’s equity allocation, as well as a broad-market mutual fund sold to retail investors. The pension has a theoretical timeframe of “forever,” and while they do not enjoy market downturns, in theory they have more time to make up those losses than a retired couple in their early 80s. And yet this retired couple may not be aware that the investment managers think in 20-year timeframes, well beyond the relevant investment horizon of the retired couple.
Portfolio management, when done well, can help tailor a client’s investment program to fit their longer term goals as well as their risk tolerance. There are many more tools available today than in years past for the portfolio manager to utilize. This is both a blessing and a curse. When assessing a portfolio manager, we recommend that you take the time to “kick the tires” of the potential new manager and get a sense for how well they understand the underlying investments they utilize.
There are many investment securities and strategies available to customize client portfolios. We don’t feel that high net worth individuals need to employ a “one size fits all” product like a mutual fund, but instead should seek a more personalized solution. At MONTAG, we recommend taking the time to find the right fit with an organization who will understand your needs, time horizons, tax implications and risk tolerances. The goal should always be to enable you to obtain the best tailored solution that fits your current and future circumstances.
The information provided is for illustration purposes only. It is not, and should not be regarded as “investment advice” or as a “recommendation” regarding a course of action to be taken. These analyses have been produced using data provided by third parties and/or public sources. While the information is believed to be reliable, its accuracy cannot be guaranteed. MONTAG employees do not provide legal or tax advice. For specific legal or tax matters, you should consult with your own legal and/or tax advisors. There are risks associated with investing in securities. Investing in stocks, bonds, exchange traded funds, mutual funds, and money market funds involve risk of loss. Loss of principal is possible.
