What’cha talkin ’bout Willis??

“Each fund’s returns are adjusted for 12b-1 fees, which are used for marketing and distribution expenses. Funds typically factor these into returns to better reflect what investors would see after these annual fees have been deducted. But our aim is to measure the manager’s skill, uncomplicated by expenses. Fund loads or sales charges, aren’t included in the calculation of returns either” Barron’s, February 9, 2015

Say what?? Barron’s just rated the BEST mutual fund companies without taking fees into account because they did not want to “complicate” things with such a trivial topic as expenses. Hmm, they may be on to something. Imagine the marketing possibilities if what customers have to pay does not have to be considered in their decision-making purchase process (e.g., having medicine available without dealing with the silly issues of research costs and side effects; purchasing a home without dealing with the ANNOYING factors of closing costs and commissions; and buying a new car without paying sales tax)! In the words of Louie Armstrong, “What a wonderful world this would be.”

In reality, considering investments without factoring fund costs borders on insanity. Morningstar has stated “Expense ratios are strong predictors of performance. In every asset class over every time period and data point tested, low cost funds beat high cost funds.” Checkmate! If Barron’s chooses to use this criteria, they should retitle it “Best Fund Managers on Fantasy Island.” These ratings might be useful for bragging rights at some snobby country club, but in no way shape or form do they help the average individual investor.

Implying that 5.75% initial sales charges, deferred loads, and 12b-1 fees are “complications” that get in the way of the manager’s true skill is preposterous. Why not then say the managers should work for free and the fund companies should make no profits to make it a fair fight? If Barron’s went to Lloyd Blankfein at Goldman Sachs with this proposal, he would most likely think he was being punked by Ashton Kutcher. Readers who look at this article may be seduced by the headlines and believe these are the returns they would receive when they purchased these funds from the “Best Companies”. While Vanguard, the low-cost giant was rated number one overall this year, the top two U.S. equity fund companies were Goldman and J.P Morgan. I do not know of any impartial, fee-only advisor who would allocate clients’ funds into these expensive products. The only way I can see these products being sold to clients, is if these institutions were paying a commission to the advisor. As a matter of fact, a J.P. Morgan employee was recently dismissed for doing the right thing and allegedly offering his client an alternative choice to Morgan’s proprietary products. As John Bogle once said, “You get what you don’t pay for.” This comment, from one of the most esteemed individuals in finance, is the antithesis of this rating system.

It is bad enough the legally disclosed fees are not factored in the rankings, but so, too, are the undisclosed expenses. Trading costs and taxes take a huge bite out of many fund returns. Taking everything into account, investors would not recognize the numbers on Barron’s pages compared to the real returns they will end up with. This is not even taking into account the famous Behavior Gap made famous by Carl Richards — meaning investors often buy and sell funds at the worst possible times,leading to much lower returns than those included in the prospectus. Morningstar displays this data in their investor return data bank. All of this flies in the face of the sage advice of Warren Buffet, “Investors should remember that excitement and expenses are their worst enemies.”

If you believe that expenses should not be included in rating the best fund companies, I have a deal for you. Make a reservation at Masa, a sushi restaurant located in the Time Warner Center in Manhattan. If you are lucky enough to get one of the 26 available tables, enjoy the terrific food. When the $400-500 price-fixe bill arrives, don’t pay it. Just say, “This bill interferes with the purity of the meal and I don’t want to complicate things.” Maybe the police will listen to the same argument when you explain to them paying bail should not be a factor in your legal proceedings. Don’t count on either of these scenarios having a happy ending, nor should you take seriously the criteria in evaluating these investment returns if costs are not included.