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Tough questions for a mutual fund manager

Franklin Templeton's Reed answers readers' queries on ETFs, fees, pay-for-performance and loss of faith

rcarrick@globeandmail.com

Don Reed doesn't just run a mutual fund company; he also manages mutual funds.

So he's an ideal person to answer some tough questions from investors about the mutual fund industry. Recently, he agreed to do just that while meeting up for a coffee here in Ottawa where I'm based.

The questions presented to Mr. Reed, president and CEO of Franklin Templeton Investments, were generated by visitors to my Facebook page (read the questions here: bit.ly/ac6gVH). Talk about a tough crowd. These people asked about issues that you rarely hear fund industry people talk about, including competition from exchange-traded funds, fees, and investors' loss of faith in the investment industry since the financial crisis.

Mr. Reed was recruited to Franklin Templeton by mutual fund pioneer Sir John Templeton and, in addition to his executive duties, he runs or helps run three mutual funds for the company. He has more than 35 years of experience in the financial industry.

A few hours before meeting up with Mr. Reed, I asked on Facebook for some questions to ask an unnamed head of a major mutual fund company. Exchange-traded funds were on the mind of most people who replied, so I started off by asking Mr. Reed for his views on ETFs.

"We've seen some growth in ETFs, but from a very low base," he said. "They are by no means dominant at this stage of the game in Canada, but they are growing. There's no doubt about that at all."

One of the questions generated on Facebook was about what the future holds for mutual funds as ETFs gain popularity.

"ETFs by and large today are index funds," Mr. Reed said. "What the mutual fund industry has to do with its active management is to outperform the index on a sustained basis. With that happening, we won't see ETFs mushroom as much as many people think."

Index investors - those who think it wiser to invest directly in a stock or bond index than have a manager choose securities for them - know well that many mutual fund managers can't match the index over the long term.

"I think people are more and more going to select those individual managers who can do this on a consistent basis," Mr. Reed said. "You don't have to do it each and every year, but you have to do it consistently over time."

ETFs have about $35-billion in assets in Canada, compared to close to $608-billion for mutual funds. But ETF growth momentum in recent years has far outpaced funds.

While acknowledging the growth of ETFs, Mr. Reed questioned the extent to which they were taking customers away from traditional mutual funds. In response to a question about whether ETF growth has hurt the fund industry's bottom line, he was dismissive.

"My response is very simple - it hasn't. ETFs are not big enough to have made a difference at this stage."

Fees came up in several questions, including one from someone who asked when mutual fund management expense ratios are coming down.

"I don't see that necessarily happening any time soon," Mr. Reed said. "MERs are a little more efficient than in the past, but I don't see a major move lower on MERs in the next little while."

In fact, mutual fund fees are going up in many cases this year as a result of the harmonized sales tax introduced recently in Ontario and British Columbia. The full HST applies on fund fees, whereas only the GST did previously.

One of the more original questions for Mr. Reed was whether there are any plans in the fund industry to move to a pay-for-performance model, where managers are rewarded according to how well they meet a particular performance target instead of through fees that are charged no matter what.

It's all up to investors to demand a pay-for-performance model, Mr. Reed said.

"If there's huge demand for this, we'll probably see it happen. But performance fees are really interesting because people want them until the fee becomes large in absolute terms. And then they don't want performance fees any more."

Finally, Mr. Reed tackled a question about his company's plans to "regain Canadians' faith toward mutual funds."

His reply was that it's up to the industry and advisers to demonstrate the value of mutual funds. Investors, he added, could stand to take a longer-term view of their portfolios.

"We hold a stock on average for five years. It would be better if the individual investor looks at things on a longer-term basis, too."

******

Don Reed: A profile

Age: 65

Executive Title: president and chief executive officer of Franklin Templeton Investments Corp.

Funds Managed: lead manager of the Templeton International Stock and Templeton Canadian Stock funds, co-lead manager of the Templeton Canadian Balanced Fund

Joined Franklin Templeton: 1989

Previous job: president of Reed Monahan Nicholishen Investment Counsel, a pension fund investment management company

Education and

designations: Bachelor of Commerce from Acadia University, Chartered Financial Analyst (CFA), Chartered Investment Counselor (CIC)

© 2007 The Globe and Mail. All rights reserved.

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