Common Cents for December 14th 2012

We don’t own a lot of actively managed equity mutual funds at Oakworth. While the statistics suggest active managers, as a lot, have a difficult time beating a passive index like the S&P 500 over time, one of my biggest concerns is the mindset of the portfolio managers. That might sound crazy, so let me explain.

Managing an individual client’s money and managing a mutual fund are two different things. While short-term performance is an issue in an individual portfolio, so are things like tax bills. In a mutual fund, the overwhelming consideration is performance, with the tax bill being of secondary or even tertiary importance. How do I know this? I have been there, and done that.

You see, mutual fund advisors incent their portfolio managers largely based on performance. Did Joe beat the S&P 500 or some other benchmark? If so, by how much? That is really the only yardstick that matters, not the tax the holders of the fund have to pay come the next April.

Further, many, if not most, mutual fund prospectuses dictate the fund be “fully invested” at all times, or at least invested up to an amount in keeping with the fund’s registration with the SEC.

For example: Portfolio Manager Joe has a diversification problem with Company X. If has run up significantly in price, and is now threatening the guidelines for “diversification” as outlined by the SEC. Basically, it is throwing a wrench in the 25% basket Joe can maintain in stocks which are in excess of 5% of the portfolio. So, he sells the stock to get back within the fund’s parameters, just to stay ahead of the compliance officer who checks such things. Again, I have been there and done that…Read On

This report does not constitute an offer to sell or a solicitation of an offer to buy or sell and securities. The public information contained in this report was obtained from sources and vendors deemed to be reliable, but it is not represented to be complete and its accuracy is not guaranteed. This report is designed to provide an insightful and entertaining commentary on the investment markets and economy. The opinions expressed reflect the judgment of the author as of the date of publication and are subject to change without notice; they do not represent the official opinions of the author’s employer unless clearly expressed within the document. The opinions expressed within this report are those of John Norris as of the date listed on the first page of the document. They are subject to change without notice, and do not necessarily reflect the views of Oakworth Capital Bank, its directors, shareholders, and employees.