Category: Wealth Management

The Voyage

Published on:
March 7, 2020
Reading time: 3 Minutes.
Last Update:

In The Cherry Orchard, Anton Chekov writes that "if there's any illness for which people offer many remedies, you may be sure that a particular illness is incurable." In this essay, I apply Chekov's principle to business research.

My point is that there are many ways to approach financial analysis. Yet, no single approach is perfect and that for investors, the right mindset is more important than any other particular technique.

The balance sheet

Investors should have a clear understanding of what the business they are buying is worth. Because only when investors understand what the company is worth can they decide whether or not the current price of the stock is over- or under-priced. I offer three approaches to evaluate the value of a business.

First, begin with the balance sheet where assets are reported at cost or market value. And the assets are classified as either short-term assets [1] or long-term assets.

But it is your job to determine what the assets are worth. For example, real estate assets are classified as long-term assets. But in a reasonable economy, any office or apartment building can be quickly sold, at market price, in less than three- to five months. 


The income statement

The second approach to determine value is by looking at the earnings. Value is closely associated with how much cash flow the business generates. If company A generates a million dollars in net earnings while company B makes half-million dollars in net profits, the former will be more valuable than the latter.

To determine future earnings, you must have (1) a general understanding of the industry dynamics[2], (2) in-depth knowledge of the business margins and business model, and (3) an understanding of the business capital structure and how it may affect operations.

The intangibles

It is also essential to look at the intangibles of the business, the third part of business valuation. Intangibles include management turnover and board compensation structure, business culture, and human capital, the brand of the company, and its position in the market place [3].

So these are the business intangibles. But there are internal intangibles as well. Internal intangibles are about you, the investor.  You must find the business you invest in to be interesting. It would help if you were passionate about knowing more about the industry. And that you are excited to follow the business in upcoming years.

Stock research is more art than math.

I, for example, made a mistake last year when I bought Frontier Communications. Lured by a what-I-thought-to-be-a-bargain price, I soon learned that now I was a proud owner of a business about which I had no interest in understanding.  In short, stock research is about art, not math. 


Top-down versus bottom-up research

There are two approaches to research businesses. In top-down analysis, investors pick a specific industry and filter out business candidates using criteria such as price to earnings or leverage ratios. For example, the gas and oil industry is distressed. The Down Jones U.S. Oil & Gas Index was 807 five years ago, and today is 463, a drop of almost 11% annually.

But the depressed industry may provide a few opportunities. Continuing with the gas and oil example, I recently looked at Gulfport Energy and Noble Corporation.

In bottom-up research, the second approach to find ideas, investors begin their journey by analyzing an individual business and comparing its valuation metrics and operating metrics to peers. Writing for Nerdwallet, Diana Yochim advises to research stocks by narrowing the focus on specific metrics, such as revenue, earnings, and return on equity.  

In both the top-down approach and the bottom-up approach, investors attempt to understand the business and industry. The main difference between the methods is the road that leads to a specific stock.

***

The famed historian, David McCullough, laments of his editor's most common question: What will be the theme of his next book? Yet McCullough explains that when he approaches a topic, whether the story of the Wright Brothers or the life of John Adams, he lets the story unravel itself. 

In other words, McCullough takes the mindset of a discoverer. That, too, should be the mindset of investors. When you analyze a company, you should not focus on the potential profit or how smart you may appear to your peers, uncovering a hidden jam. You should not have an agenda at all. Instead, akin to McCullough, more important than anything else, is that you have the mindset of an explorer. 

FOOTNOTES: [1] That can be liquidated in less than one year. [2] For example, are low-cost providers stealing market share?

The Money Game

Published on:
January 4, 2020
Reading Time: 5 Minutes.
Last Update:

Last week I visited the headquarters of a local real estate company that owns, manages, and develops apartment buildings. The company, which shall remain anonymous, operates about 70 apartment buildings in the western part of the United States. It has over 400 employees, and in the past year, it bought over a billion dollars in real estate.

The founder's focus in the early days was to buy distressed properties from banks. And from that humble beginning in the 1990s, with grit and tenacity, he grew the company to be one of the most respected apartment operators in California. 

This essay is inspired by my conversation with him. Where I learned how much business has to teach us.

Price matters

A good business does not make for a good investment necessarily. Last week, I attended a webinar where one of the speakers explained that Coca Cola is a "compounder stock." By that, he meant that whether you bought the stock in the 1980s, the 1990s, or in the current decade, you would get a good return. 

Really? As a careful student of finance, I looked at what Coca Cola was trading for between 1997 and 1999. It was easy to see that you would have to wait for about a decade until you saw the price of the stock return to your cost basis. I don't know many investors who have that kind of patience.


Career advice

Consider Salesforce.com (CRM on Nyse). At $163 per share, this cloud-based software company is trading at over 90 times the earnings. And a quick review of their website tells you why investors willing to pay the hefty multiple. Salesforce focuses on software design, big data analysis, and artificial intelligence. Choose any path for a career, and you likely do well. 

The inverse logic works just as well. You should probably avoid low p/e industries. For example, both Noble Energy (NBL on Nasdaq) and Murphy Oil Corporation (MUR on Nyse) are trading at less than five times the trailing earnings. (So, why bother with a profession when you know you will compete on positions with experienced candidates?) 


The nonlinearity of life

Consider Nvidia Corporation (NVDA on Nasdaq) as an illustration of the nonlinearity concept. Between 1999 and 2016, investors in Nvidia saw a rate of return of about 8% [1]. But investors who bought Nvidia in 2016 saw a rate of return of 52%, a fourfold increase. (Nvidia now trades at $238.)  

Similarly, life is not linear. There are times when we feel stuck and lack  vision for the future. And at such times, going over the historical record of companies such as Nvidia, which shows an overnight success (that took the company to achieve over a long period)  I find to be to alleviate the mood. 

_____
A NOTE FROM NOAM 

In Pen&Paper, I only write about companies I am personally invested in, and on finance topics, I find it important to share.

Buying a stock is easy. But it requires a lot of effort and discipline to keep track of the company's performance. And no matter how much a stock appreciates, you're not capturing those returns until you sell. Join the waitlist to get real-time updates.

_____

The impact of few events

In Brave Companions, the historian David McCullough tells that the time former president Teddy Roosevelt spent in Medora, a little town in the Badlands of North Dakota, had a profound effect on the former president's life. Similarly, I believe that just one or two stocks will have a profound effect on your life. 

Take Amazon, for example. If you bought $10,000 worth of shares a decade ago, the value of the position would today be 33 times higher, $330,000.  If you had placed the same amount of money 20 years ago, you would earn 100 times your money. The value of your Amazon position would be a million dollars. 


A gate to human pyschology

By studying the stock market, you read and experience fear, greed, euphoria, , and times of immediate and unexpected duress [2]. 

Not only will you learn about the psychology of other investors, but you will also better understand your psyche.

Not only will you learn about the psychology of other investors, but you will also better understand your psyche.


Inspiration

My parents visit Paris each year and marvel at the ingenuity of the Impressionist era. And how can we not marvel at the wonders of business. 

Want to study the art of business? Just read about the annual report by MasterCard, Maotai, Markel Insurance, and Moody's.  

Many find inspiration in the words of Shakespeare and Henry James. And to me, annual reports can be a form of literature. I love reading annual reports by  Carriage Services (which I bought last year), Jamie Dimon at JP Morgan, and Warren Buffett at Berkshire Hathaway. 


Global exploration

Stock research is also an opportunity to explore the world. A friend of mine looks for companies outside the United States that share a similar business model to successful, U.S-based companies. So, for example, she will look for Indian-equivalent Moody's. Or the South-Korean equivalent of a stock exchange such as the New York Stock exchange. 

Last month I bought a few shares in Micron (I will publish the investment idea in the upcoming weeks (write to me if you would like to be notified when I post the investment idea). And I quickly realized that geopolitical tensions resulted in a 10% loss in revenue. 

It is one thing to read about geopolitical tensions, from the sidelines. But the effect is different when a business you own is hurt.


The long term outlook

Where the business will be in ten years is one of the first questions I ask before buying a business. For example, it is reasonable to assume that in ten years, we will keep chewing gum (say, Wrigley's) and that we will drink soup in the winter (say, Campbell's). So it is reasonable to project ten-year cash flow and to compare the net present value to the current price. But who can predict where our payment system will be in ten years? 

So when you buy a stock with a long term outlook, you tend to ignore daily market movements. And thinking over the long term requires you to focus on the business fundamentals, whether management is capable and invested in the business. And whether the industry is growing. In short, the stock market also teaches us to focus on what matters. 

FOOTNOTES [1] Nvidia became public in 1999, at $12, and the shares traded at about $45 in 2016. [2] For example, the 2008 recession, valuation of tech companies in the late 1990s, the Great Recession of the 1930s, and the interest rate environment in the 1980s. [3] If the Mexican government built a needle coke plant, and I estimate that only public funds can raise that amount, Graftech's business will suffer.

On Relationships, Marketing, Processes, and Habits

Published on:
December 21, 2019
Reading Time: 4 Minutes.
Last Update:

Life in equity research is about asking questions. It is about wondering what exactly did Fiserv, a financial services company, do over the past decade that drove the stock price tenfold [1]. It is thinking about how, after 105 years, General Electric was part Down Jones Industrial Average, it lost its place.

"If he [Charlie Munger] were teaching finance, he would use the histories of 100 or so companies that did something right or something," writes Jennifer Lowe in Damn Right! Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger. 
"Finance properly taught should be studied from cases where the investment decisions are easy."

Life in equity research is about understanding businesses. Not academic theories.  

That studying business is at the heart of equity research was not clear to me when I started this journey. When I studied for Chartered Financial Analyst (CFA) exam[2]. During that period, I read investment topics such as the risk management application of option strategies and reviewed foreign exchange concepts such as forward markets and sport markets. While these topics, perhaps, are of interest to the student of finance, they serve little in the hunt for the next Amazon.      

Cultivating relationships

Another subject absent of finance programs is the value of relationships. I believe that none of the legendary investors would achieve success if they didn't have a supporting spouse, a loving family, a community to belong to, and outside interest beyond the passive ownership of equity interests. In other words, developing soft skills is as vital as understanding GAAP accounting.  

One example of a life skill is creating goodwill. It is so much easier to ask someone for help when already you have assisted them in the past. In our time of just-because-what-can-I-lose Linkedin requests, you will gain an advantage over your peers if you carefully develop an ecosystem of friends that genuinely care for one another.

And developing and maintaining relationships requires work. It is about spending time each week thinking about how to bring value to others. It is about small acts of kindness and putting the focus on others. It is about remembering what Viktor Frankl used to say in the name of Kierkegaard. That the 'The door to happiness opens outward.'

The door to happiness opens outward.

Understand: Whether the stock portfolio increases in price over 12 months is mostly dependent on factors beyond your control. But whether you build genuine life-long relationships is entirely up to you.  

Bringing business development efforts to nil

There is tension between investment research and the business of investment management. I estimate money managers use between half to three-quarters of their time in the latter. They travel to meet prospects, they speak at conferences, they interview at any opportunity.

From conversations I had with money managers, I learned that many of them would much prefer to replace the ratio of business development to investment research.

I don't have an answer on how to do that. My personal story is that I saw this inherent tension between the research and business side of things. And I decided to avoid managing other people's money so that I won't have to spend time explaining to them my investment decisions.

Business development becomes crucial when fund managers hire a team of professionals. As I wrote in January of this year,

Hiring a team of analysts will distract the asset manager with tiresome managerial duties. And instead of carefully reading about investments, the manager will eventually sift through the analyst's cliffs notes.

Read more in Mohnish Pabrai's Ten Commandments of Value Investing.

In short, I keep business development efforts to nil and decided to be a team of one. Read Paul Jarvis' Company of One, to learn about this model of work.


The lifestyle of an equity analyst

There is no single formula for life in equity research analysts. Your lifestyle is different when you have young children compared to your lifestyle when they are in college. Not unlike life, the investment life is much different when markets are fully priced compared to market everybody is selling.

While there is no fixed, daily time structure, I find it useful to have a few key performance indicators (KPIs). These KPIs allow us to keep track of progress.

For example, in a particular one month, I will write in my Bujo calendar: "This [Month] I will read [Number] 10-k reports. I will read about the business model of [Number] companies from [Number] investment newsletters; and track the stock activities, via 13-F filings, of [Number] fund managers."

Your lifestyle should drive investing decisions. These decisions should not drive your lifestyle.

Some investment ideas take months to understand. For example, I bought GrafTech (read the GrafTech article) after researching the industry and the competitive landscape for weeks. Others are much faster. I recently bought Micron in less of six hours of research (Write to me if you would like to know why.)

How to measure success

In The Big Book of Endurance Training and Racing, Doctor Philip Maffetone ridicules the 'no pain no gain' fitness concept. He explains that "this is an emotional reaction - one that is based on current trends, often started by advertisements and other marketing - and one that can be irrational."

The 'no pain no gain' attitude is irrational because you should listen to your body's intuition. And the same can be said about the myth of "no risk no reward." (Read more about this myth and other investing myths in The five myths of stock investing.)

Success in the stock market should be about processes. Not about a percentage point more or less compared to the performance benchmark. In the long run, your financial success is the knowledge and wisdom you accumulate about business, the relationships you cultivate, the investing principals you follow, and how you chose to live your life.

You will never hear investors in their later years regret making that they didn't earn a extra percentage points to their investors. More likely that they will lament that they didn't spend enough time with the people they loved and didn't make an effort to make the world a better place.

When asked by William Green, about the key to a fulfilling life, the legendary Irving Kahn remarked:

"For me, the family has been very important. Having a family, healthy children, seeing what we've achieve at the firm. These have all given me great pleasures."

We know that we should explore and travel the world. We should inspire others to lead. And we should remember and recite what former President Theodore Roosevelt said, "I have never in my life envied a human being who led an easy life. I have envied a great many people who led difficult lives and led them well."

And that is life in equity research.

FOOTNOTES
[1] Fiserv stock went up from $12 in 2010 to $117 in 2019
[2] I passed the CFA exam in five years of work.

This Too Shall Past

Published on:
November 13, 2019
Reading Time: 3 Minutes
Last Update:

Timing the markets is hard; perhaps, impossible. But it is easy to see that market prices widely swing.

In this essay, I describe the investing performance of past and current value investors. As you will shortly read, all legendary investors reported poor results at times. The active investor should know that even great investors failed to correctly time markets. 

For the passive investor, I bring the historical record of indices such as the S&P 500 and the Dow Jones. Here, my goal is to show you that if history is any evidence of the future, then markets swing in price. 

So if you invest in an active mutual fund or an exchange-traded fund (ETF), unless you can calmly withstand market swings,  you are best to buy assets that do not have a daily market quotes.

The active record

Even great investors reported paper losses [1]. The legendary Walter Scholls wrote to investors of a 5% loss in 1957, followed by a 9% loss in 1969 and an 8% loss in 1970. 

During 1973 and 1974, Scholls reported a loss of 15% during each of those two years; Sequoia fund, another legendary fund,  reported a loss of 38% during those years. Even Charlie Munger lost over 53% [2].

Let's fast forward to current examples. Between July 2007 and June 2008, Mohnish Pabri lost 32%, and in the following year, he suffered an additional 25% paper loss. In other words, in two years, the market value of a $100,000 investment was halved. 

Pabrai, whom I admire and who much influences my thinking, also reported a loss of 22% in June 2012. So let the record show that even great minds experience bad years.

Another investor whom I consider to be one of the greatest is Guy Spier.  In 2008, he reported on a 47% loss and a 16% loss in 2015. He writes in The Education of Value Investor 

"2008 was something else. I'd never experienced an avalanche like this within my portfolio. The serious damage began in June when the fund fell by 11.8%. The following month, I was down another 3.5%. And then things started to get ugly. In September, it tumbled by another 12.5%. For the year as a whole, I was down 46.7%. On paper, almost half of my shareholders' money and my family's money had gone up in smoke."

(To clarify: by no means is this an attempt to embarrass Pabrai or Spier. The goal here is to show you that it is a certainty that you will see paper loss if you invest in the stock market. Whether you invest on your own or let others manage your money.) 

The next section is for readers who are disinterested in neither investing on their own nor in a fund. This section is for those who choose to invest in the stock market using ETFs. 

The passive record

If you were bullish [3] on the United Stated economy and, say, a decade ago placed a $100,000 bet in an ETF that tracks the performance of the S&P 500 index, the value of your position would now be $271,000.

And compounded growth of about 12% over ten years may now affect your expectation levels. Yet it is unlikely you will get double digits return from a single-digit growth economy. 

In Bull!, Maggie Bahahr shows why. She provides three examples of market cycles. First, between 1882 and 1897, 15 years, the S&P 500 total return was 3.4%. Between 1903 and 1921, 18 years, the total return was 0.6%. More recently, the S&P 500 annual return between 1967 and 1982, 15 years, was 0.2%. And between 2000 and 2004, the annual total return was negative 5%.

Can you imagine the frustration of parting with cash for 15 to 18 years only to realize that you are no better off than when you started?

Not only do market cycles affect return, but the annual return also affects the investor's psyche. For example, between 2000 and 2003, the S&P 500 lost value. If you had $100,000 in the stock market, the value of your portfolio would be $60,000 three years after. In 2008, the market lost that same amount of value in a single year - the S&P 500 lost 38% in 2008.

Both the Dow Jones Industrial Average and the Russell 2000 show similar results. Between 2000 and 2003, the Dow lost 28% in total, and in 2008 it lost 34%. The Russell 2000 dropped 21% in 2012 alone and 35% in 2008.

***

There is little we can do to stop, delay, or change the natural swings of markets. But two things are in our control. First is an awareness. Knowing that you will have a significant paper loss at some point should leave you less troubled when the day arrives. You will know that this too shall pass [ 4] .

Secondly, keep cash handy. It is one thing to see the market price of your portfolio drop - yet it is terrific when price declines allow you to buy great businesses at excellent prices.

FOOTNOTES
[1] Paper loss is the unrecognized loss in a stock's market value. 
[2] Performance results taken from The Superinvestors of Graham and Doddsville as written by Warren Buffett in 1984.
[3] Bullish in a sense you believed the economy would become stronger.
[4] This adage was notably employed in a speech by Abraham Lincoln before he became the sixteenth President of the United States.

Zero Management Fees

Published on:
October 25, 2019
Reading time: 7 Minutes.
Last Update:

This article gives a reason for the zero-fee structure. I discuss the lure of the structure and some of the potential pitfalls. I conclude the essay with a practical review of how fees, both explicit and implicit costs, affect returns over the long-term. My main point is that there is no way to invest without paying fees.

Zero fee structure in a mutual fund and a fund partnership

Mutual fund

When mutual fund managers declare zero management fees, they are waiving three costs. The initial cost is an asset fee, which typically ranges from 0.50% to 2.0%. The other expenses are load fees. "A load is a type of commission," explains Wikipedia.

The third costs are distribution and service costs, also known under the technical term of 12b-1 fees. These costs compensate mutual fund managers for marketing and for providing shareholder services. Visit distribution and service fee on Wikipedia to learn more.  

Two examples: Third Avenue Management, a mutual fund I admire, charges its shareholders a 0.90% management fee, distribution fees of 0.25% and other expenses of 0.30%. The total annual fund operating expenses are 1.45%. So if you invest $10,000 with Third Avenue, you will be charged $145 per year. Download the Third Avenue Value Fund to read more.

Fidelity funds have no fees. Consider Fidelity ZERO Total Market Index Fund (FZROX) as example. It opened in August 2018, the fund today manages $3.9 billion in assets. It aims to track the performance of large-capitalization U.S. stocks using automatic trading algorithms. Household, large-capitalization companies such as Microsoft, Apple, Amazon, Facebook represent about one-fifth of the fund. Visit ZFROX to learn more.

Hedge funds

Yet when fund managers [1] speak of zero fees, they refer to something entirely else. Fund managers will require at least 1- or 3-year hold time, which means you will not withdraw funds from the partnership during that "lock-up" period.

Another change in the partnership structure as a result of the zero-fee structure is that the manager's fee, known as carried interest [2] is higher. For example, under a one percent fee, the managers' interest in the profits may be 10%. Under zero-fee structure, the manager's compensation may jumpt to 20% of the profits.

What lures about zero-fee structure

The right performance evaluation

How you evaluate performance is essential. And the manager's performance evaluation should be judged using the change in the after-tax market value of your investment.

Payment for value

Under the zero-fee structure, only if the fund performs, the fund manager is paid. That is, you pay the manager only if the fund's fund returns are above a hurdle rate.

But the practice today is that you pay fees irrespective of the fund's performance. With a management fee, a fund may have lost market value during the year, but you still pay the fund manger.  

The zero-fee structure is a value-for-value trade. You only the managers only if you got value.  

The Buffett-Pabrai effect

Zero-fee structure appeals to investors because of great investors. Warren Buffett started the Buffett Partnerships in the 1960s with a similar structure. And Mohnish Pabrai, inspired by Buffett's biography written by Roger Lowenstein, had copied the zero-fee model in the late 90s.

And since both investors performed well for their investors, logic prescribes that a zero-fee structure results in success.

Yet, as the science community knows, there is a difference between causation and association. It is more likely that both Buffett and Pabrai would have achieved high returns regardless of the fee structure.

At least, when a fund manager offers you zero fee structure, you know the manager commits to performance. And that they probably read and studied Buffett and Pabrai - a blessing in itself.

_____
A NOTE FROM NOAM 

In Pen&Paper, I only write about companies I am personally invested in, and on finance topics, I find it important to share.

Buying a stock is easy. But it requires a lot of effort and discipline to keep track of the company's performance. And no matter how much a stock appreciates, you're not capturing those returns until you sell. Join the waitlist to get real-time updates.

_____

The downside of zero-fee structure

The impracticality of the structure

But after two- to five-years of lousy performance, can we expect of managers to open their doors? Most funds have a hurdle rate. So when capital markets drop, payments to funds managers may not be for a while, six- to eight years of wait time.

Very few managers can wait that long. It remind me of the story of how Benajmin Graham dissolved his fund only after his investors recouped their capital. Or the story of Pabrai, patiently waited for a decade before pulling any money from his fund. But these are out of the ordinary stories, not the rule. I believe that for every one Pabrai, there are over a hundred managers who would walk away from the fund.

For every one Pabrai that stuck around, there are hundred managers that would walk away.

An appetite for risk

Another cause of concern is the fund manager's increased appetite for risk. Knowing the only way to get paid is by stellar performance, managers may take additional risk because of the zero-fee structure.

Marty Whitman once wrote that "an adjective must precede the word 'risk.'" Here I use the word 'risk' in two contexts. One, when fund managers lack time to research and two, when they look for stocks outside of their circle of competence.

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ADVERTISEMENT

Founded in 2004, by Charlie Tian PHD, GuruFocus provides institutional-quality financial stock research for the individual investor.

GuruFocus hosts many value screeners and research tools and regularly publishes articles about value investing strategies and ideas. One of the features I use most is the 30-year financial information on businesses. For example, see how easy it is to review AT&T balance sheet.

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Lack of empirical data

Intuition aside, there is little to show that zero management fee structure is superior to any other form of fund arrangement. There are too few zero-fee funds to track. And the fund fee structure is outside of the student of finance scope of interest. Outside of common sense, the argument for zero management fees is unbacked by any data.

I am not sure there ever will be enough data to back the zero-fee structure. A fund performance depends on factors that work at the same time, and that cannot be isolated.

Research does not always support decisions. Among those: the partner we decide to marry and the business venture we choose to take and also the outcome from the principles in life we want to have. Perhaps - and not unlike in real-life -  investment decisions require a leap of faith.

Investing requires a leap of faith.

The cost of fees over the long term

Explicit costs

Page 4 of The Manual of Ideas shows a table the SEC should require fund managers to show their fee-paying customers. The table shows that a 2% management fee will cut the value of your portfolio by 22.2% after ten years; by 39.4% in 20 years; and 52.9% over 30 years. The assumption is of a 5% gross return.

Implicit costs

In a talk [3] given in 1994 to students of the University of Southern California, Charlie Munger retells the story of Federal Express's early days. Employees left packages in the warehouses. Which penalized the company's profits. So management decided to change the worker's compensation from an hourly basis to a shift basis. You got paid when the work you completed the work, not when the clock said it was five o'clock. Unsurprisingly, perhaps, the new structure dramatically changes the number of package deliveries.

In Munger's words:

"As usual in human affairs, what determines the behavior are an incentive for the decision-maker, and 'getting the incentives right' is a very, very important lesson."

Not unlike Federal Express workers, salary structure changes the fund manager's behavior. When the portfolio size determines wages, managers naturally focus on increasing the size of the portfolio. They will talk to CNBC reporters; Work with advertising agencies on brand awareness. It would be better if managers focused their attention to the portfolio needs and no to what the market thinks about the portfolio.  

The fund industry somehow managed to market their services differently. Mutual funds charge you not as a percentage of the actual revenue, but as a percentage of the assets under management. This incentive structure results in much higher management fees.

For example, with a 1% management fee, mutual fund managers will charge you $100 annual management fee for every $10,000 you invest with them. In today's capital markets environment, on average, managers will earn  6% on average on your investment. We find $600 in management fee. But we would expect that they would charge 5% to 7% of that, which is $30 to $40. Yet, since using the investment management's calculation of fees, you will be charged $100, more than three times what a real estate relationship would require.

The investment management industry charges more than three times what a property manager would charge.


Read about this phenomenon in Investment Management Fees are (Much) Higher Than You Think.

***

You should now be able to assess the benefits and drawbacks of the zero asset management fee. If you would like to add to the article or you still have questions about zero asset management fee, write to me. I always respond.  

For additional information, I suggest that you also read Guy Spier's white paper on zero management fees. Also The New York Times recently published an article this trend. Visit this page to read more.  


FOOTNOTES: [1] Fund managers are managers of either a hedge fund or a private equity fund. [2] Carried interest is the share of profits paid to fund managers. [3] The talk's name is a lesson on elementary, worldly wisdom as it relates to investment management business.