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Maverick managers hit on brainwave: Put investors first

Inside the painted white walls of a basement in a north Toronto, three men are plotting their revenge against Bay Street.

All three were once well-paid portfolio managers or analysts at TD Asset Management, the mutual fund management arm of Toronto-Dominion Bank. They could still be riding the gravy train, collecting six-figure salaries and enjoying the profile that comes with working for one of nation's biggest fund firms.

Instead, they have started their own firm -- partly because that's what money managers do when they get bored with their jobs, and partly because they deplore what the $465-billion Canadian mutual fund business has become.

They're making peanuts, working in a small room in the basement of one of the partners' homes. But they have a point to prove. The mutual fund business is failing, they say, because it places too much emphasis on collecting assets and charging high fees and creating new, flavour-of-the-month funds, and too little on making money for their customers -- mostly middle-class investors who have few other options because they're not rich enough to qualify for higher-end, lower-cost investment counselling services.

These are familiar accusations. What's striking is that they come from people who for years watched the fund industry from the inside.

"When your boss is a marketing guy, and when the business is based on products and volume, it's not really helping the investor out," says Bill Harris, who spent most of his career at TD and Sentry Select Capital before bolting this year for the new firm, Avenue Investment Management.

At one point, he says, he was managing nine funds with 160 different stocks. It's nearly impossible to follow 160 companies and know them all well, but that's one the fund industry's dirty little secrets: A lot of managers are investing your money in companies they don't really understand.

Here's another. Think mutual fund managers are on putting their money where their mouth is? Many won't put their own cash with their clients. "I never had a single dollar in one of my funds," Mr. Harris says.

Nor, it seems, do the fund companies do what those in other industries do, and give their customers a refund when they've sold them a defective product.

To take one example from the Avenue principals' former employer, look at the TD International Growth fund, which has accomplished the truly astounding feat of losing money over a 10-year period. A $1,000 investment put into the fund in April, 1994, is worth $844 a decade later. And yet, year in and year out, TD collects the 2-per-cent management fee from the fund's investors.

So, the trio from Avenue -- Bill Harris, Paul Harris (no relation) and Paul Gardner -- have set out to try to fix the flaws of the business. Their shtick is simple. They keep their stock portfolio trim -- 30 stocks, large enough to be diversified but small enough that they can keep an eye on them all. They put their own money into their funds.

If they have a losing year, they will cut their management fee in half, from 2 per cent to 1 per cent. The flip side is they take a performance fee in any year where returns are higher than 10 per cent, similar to a hedge fund. Unlike hedge funds, they're not shorting stocks or using leverage, which can increase returns but also raises the risk. And, unlike most investment counselling firms, which cater to only the wealthiest clients, Avenue is going after the mutual fund industry's sweet spot: investors with $50,000 or $100,000 to put in.

Pay for performance. Fund managers willing to put their money with yours. Imagine if these ideas were to catch on in the mutual fund business.

© 2007 The Globe and Mail. All rights reserved.

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