Tough questions to ask managers of mutual funds

Your Funds

Your Money

February 06, 2007|By Charles Jaffe | Charles Jaffe,Marketwatch

If you could ask your mutual fund manager anything, would you really want to know which past winner from American Idol was his favorite?

It's a silly question that I pondered after watching some of the "Media Day" festivities during the buildup to the Super Bowl. Media Day is when the teams make players available to the media horde, and while I appreciate a writer's desire to find a fresh angle or coax a clever quote from a star - someone actually asked about Idol - I also recognize the missed opportunity to get real information and settle for the superficial.

When it comes to mutual funds, there is no equivalent of Media Day. While managers sometimes face reporters at a conference or speaking event, few funds hold shareholder meetings, and few investors get to ask probing questions - no matter how serious or silly - of the person who runs their money. But let's say, just for a moment, that shareholders could have a sit-down with their managers. What questions should they ask?

There's a wide range of possibilities, and answers to some of those questions are available, even if you don't have access to the manager.

"You're not going to be invited to sit down with your fund manager, but you can get answers to some of the questions you'd want to ask, either from the prospectus, the [statement of] additional information or by calling and asking," says Michelle Smith, managing director of the Mutual Fund Education Alliance. "Talking to the manager would be more fun, but if the information is important to you, find another way to get it."

In case you ever meet your mutual fund manager, here are some questions to get the conversation started; assuming you won't get that chance, consider looking for the answers in your fund's documents or from its service representatives.

In plain English, why do you buy and sell something?

Funds often give complicated descriptions of what they do, speaking a language of jargon and legalese. Most managers have a simple explanation. They buy stocks with certain characteristics, and sell when those traits or conditions change.

A manager who can't describe his strategy in three sentences is either making things complicated or trying to come up with plausible excuses for when things go wrong.

Do you invest in the fund? How much of your wealth is at stake?

The first question is answered in the fund's statement of additional information, but the second question - which is not - provides context.

Knowing that a manager is eating their own cooking - and has their own interests aligned with you - is comforting. Says Frank Armstrong of Investor Solutions, a financial planning firm in Miami: "If your small-cap manager is investing in someone else's small-cap fund, you probably would want that other fund, too."

While managers sometimes say they don't invest in their own fund because it's not appropriate - maybe they're too young to load up on the conservative bond fund they run - there's no excuse for not having some skin in the game.

"I'd like to know how much of the manager's future is at stake," says Gregg Brewer, executive director of research at Value Line. "Some managers could have $100,000 in their fund, and it's less than they get in a quarterly bonus. I'd like to know that the manager trusts the fund with as much money - relative to their net worth - as I do, that they've got 10 percent or all of their money in the fund."

How do you earn a bonus? What incentives are you trying to reach?

Some managers are compensated based on short-term results, others for long-haul performance. Some need to be at the very top of the heap to max out their pay, while others need to beat their peers or a relevant index, or to simply be consistent. Managers want to max out their incentive pay, so they'll manage the fund to do that; knowing their incentives helps you determine what kind of ride you'll get from the fund.

What gives you a competitive edge in this market?

This question might have worked on Super Bowl Media Day, but it also works for fund managers, because investing is a competitive, numbers-driven business.

If a manager - or a fund company - can't tell you what makes them superior to the competition, you should wonder if they really are better. While the proof is in the performance, knowing management's thinking before playing the game helps you determine where to place your investment wager.

What will happen if you leave the fund?

If you're talking with a star manager whose presence was a big reason for investing in the fund, this is a serious concern.

Says Smith: "The company line is always that things will be great, and everything is OK, but you want to know what they're planning - and that they actually are planning - especially if you bought the fund because you trust the manager."

Charles Jaffe is senior columnist for MarketWatch. He can be reached by mail at Box 70, Cohasset, MA 02025-0070.

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