MUTUAL FUNDS. ARE THEY YOUR FRIEND?

Mutual funds have been around for a long time, since 1924 in fact, when Massachusetts Investors Trust started a fund with 45 stocks. They have really caught fire over the last 20 years or so, and they have become behemoths, but is that a good thing? Frankensteins are usually trendy at first, but when they develop their own will, sometimes they turn on us.

Take for example the equity that some of the Canadian mutual fund giants wield. Investors Group, $36 billion, TD Asset Management boasts $32 billion, Columbia Wanger, $22 billion, and the list is endless. They have exploded since 1990 for several reasons.

When our financial institutions began selling mutual funds, it popularized them to the average consumer. No longer were they available mainly to financial planners and the like. They are easily switched over to cash, and they are safer than owning a single stock. If a company that had stocks in your fund when belly-up, it only affected a portion of the fund, versus losing all if you were to only own that particular stock. Also, in the 1990’s, the funds were paying extraordinary returns as opposed to savings accounts and GIC’s, and finally, they are managed by professionals.

While professional management is indeed good for the long term growth of the fund, this is the point at which mutual funds become a bad thing. Mutual funds have become so huge that the managers who control all that capital have a lot of pull. Companies who rely on public shares for raising capital of their own are at their mercy. The bigger the fund, the bigger the companies whose stocks are traded, and if a company wants to stay in that fund to be able to utilize the capital that is made available as their stock price rises, then they are ‘informed’ by these managers and their analysts what areas they are lacking in.

Let’s say you work for a company called Bill’s Steel. Things are going well, but the steel plant down the street is doing better. They have modernized the plant, streamlined operations, and last month, they laid off 2000 workers. Now Bill’s Steel relies on some public money to operate. Bonds and other debts come due, and sometimes new bonds are issued to help with expenses. The collateral for these bonds is the worth of the company more or less, that is, the value of the stocks. It is imperative for Bill’s that their share price stays put. In comes the manager for ABC Mutual Funds.

ABC holds a lot of your outstanding shares. 8% to be exact, and ABC has some insight for you. You are falling behind, and you must immediately improve productivity, even perhaps streamline your workforce. Failing to act would perhaps cause ABC to sell off some of your shares, citing that your productivity is declining, and your share price would likely begin to slump. Bill’s Steel must do what it has to. It must stay with the industry.

Guess who just got laid off? You. The guy that has worked there for 20 years, and every February, like a wise worker would, you planned ahead for your retirement, and put your money in RSP’s. Probably in the form of mutual funds. Aren’t you surprised that the guy who persuaded your boss to let you go did it because he had control over the money that you had saved?

From 1990 to 2001, assets for mutual funds in Canada grew from $25 billion, to $426 billion. Total US mutual fund assets are now worth $1.89 trillion. The industry has gone from $1.065 trillion, to $7.4 trillion.

While this column may have simplified quite a few of the details, I am sure you get the idea. While mutual fund managers themselves are not to blame, the system is what it is. What can we do about it? Not much, except finding other sources to save your money in. Mutual funds sometimes do very well, but perhaps the great returns you think you will get on them come at too high a cost.