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The Return of Capital:


Experienced investors cringe at the sheer mention or sight of this word and for good reason. Many investors realize that fees eat into their returns and few investments come without them. Exchange traded funds (ETF’s) and low cost trading commissions are available to investors, but even if your invested assets are of a reasonable size someone always seems to have a hand in your pocket as you try to make money in the markets.

2008 taught investors very important lessons and many are still feeling the pain as they re-evaluate their risk tolerance, portfolio allocations, investing objectives and attempt to access their capital for new changes in 2009.

I’ve wanted to write a post on this topic for quite some time but only recently in conversations with a few new investors did I feel compelled to put my pen to paper.

I have a saying when I educate new investors about mutual funds which goes something like this,

“This is your money that is being professionally managed – it shouldn’t be professionally stolen.”

In my opinion many mutual fund companies, money managers and financial professionals commit robbery with reference to their fees. Two percent (2%) might not seem like robbery when you examine your returns on a year to year basis, but consider this: 2% each year over a ten year period results in 20% of your potential investment lost to fees. That goes for both up markets and down markets.

The difficulty I have with fees is…well…it’s your money. I don’t advocate that a professional managing a portfolio should work for free but fees should be proportional to performance and the hands on approach of your specific advisor.

The concern I have today is with regards to your return of capital which is far more important than the return on capital.

I’m not talking about return on capital or return on invested capital; those are completely different concepts in business. I’m talking about the return of your capital when you ask for it, make a decision to change how your money is invested or choose to simply walk away from a professional you’re not satisfied with.

Questions: (feel free to put up your hand)

Who reading this has paid DSC fees before?
Who has paid DSC fees without knowing what they were?
Who has no idea what DSC fees stand for or if the mutual funds you own charge them?

DSC (deferred sales charge) fees are often hidden gems of the mutual fund industry that require investors to pay a fee (often substantial) on a declining yearly basis to have their capital returned to them if they choose to sell. These are of course on top of the yearly MER’s (management expense ratios) that a mutual fund manager will charge an investor and trailer fees your advisor receives from those fund companies.

Right now these gems are turning out to be landmines when investors seek to sell their funds in order to switch strategies, investment advisors or mutual fund company altogether. Investors are receiving a reality check when they’re informed that 4-6% of their invested assets are now eligible for these fees and investors’ angered responses aren’t very polite for obvious reasons.

I’m not attempting to place blame on advisors or mutual fund companies although they do deserve most of it. Investors themselves hold a responsibility to ask questions about how their money is managed and those who handle your money have a responsibility to fully disclose fees so that you understand their impact.

What I want to bring to the attention of readers is how I believe the financial industry does a horrible job of returning your capital to you when you request it. In all fairness to the financial industry this is your money. You should be able to do with it what you please within a reasonable time period. The purpose of these fees is not to necessarily rip investors off, but provide a serious disincentive and discourage you from moving your money away from a fund or manager.
The lack of transparency and education in the financial industry is literally appalling and very few individuals hold themselves to a high and respectable standard.

Little investors aren’t the only ones hurt by the features of DSC fees as many wealthy investors who invested capital in the hedge fund industry are now finding out. Gating is a provision placed on many hedge funds that limits a specific amount of money from being withdrawn from the fund during a period of time. Many investors were unaware of this provision and during the selloff in the market in 2008 many who asked to have their capital returned to them were swiftly denied. The gates closed on the fund and are now unavailable to shareholders.

I think of this as the money bin from a childhood cartoon I watched (Duck Tales) with Scrooge McDuck at the helm of his town’s finances. Wealthy investors gave Scrooge their money to invest because of his miraculous wealth and historical financial returns. When the markets went south investors started demanding the return of their capital and Scrooge let his investors take out 15% of assets and then promptly shut the gates preventing investors from pulling out their money.

It’s important to note that whether the hedge funds go up or down in value over the gated time period individual investors are now forced to watch this money sitting beyond their reach. They could make 20% or lose 60% of their invested assets and legally have no way to force the hedge fund to repay them their capital.

In Part II of The Return of Capital I will be sitting down with a Canadian investor who recently learnt some important lessons about his finances when he decided to make some changes to his managed portfolio. In this investor interview we’ll discuss DSC fees, mutual fund selection, budgeting tips, resources for new investors and important insights on the financial services industry.

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{ 6 comments… add one }
  • Anonymous February 8, 2009, 4:40 pm

    I have personally had this experience!

    Since then I have moved ALL me accounts from my so called “financial advisor” ( who was loking out for himself more than me).

    I have moved to a discount broker and now handle all my own money,,,,purchasing dividend paying stocks or trusts when the price seems right.

    I am seling out of these mutual funds little by little , but have been stymied at times by the dam fees to get at MY OWN MONEY!!

    to whoever is reading this,,,,trust no-one but yourslf,,,and NEVER buy a mutual fund, EVER.

    If you want to play the indexes,,,buy ETF’s.

    good luck,

  • Anonymous February 17, 2009, 1:23 pm

    I totally agree, having fired my mutual fund advisor many years ago. Make sure to read the follow-up post: “Return of Capital II”. It is an extremely good article and should be mandatory reading for ALL investors!! The mutual fund industry is finally being exposed for what it is-Gangsterism!! You assume all the risk and they realize the profits, no matter what the market is doing. Nothing more than common thieves. And Seg funds are nothing more than a new twist on an old con that is working quite nicely for the fund industry. Once people figure out they don’t need the so-called “pros” anymore, investing will be a lot more fun and profitable!!

  • Anonymous March 7, 2009, 9:21 pm

    Yeah right.

    I’m sure everyone I know has no life to speak of and would much rather spend countless hours researching stocks then spend time with their families.

    My advisor saves me 10 times more tax every year than what I pay on MER’s with my funds. The problem is, most Canadians get their advice from the banks and those so called “advisors” are nothing more than mutual fund salespeople. Get a REAL advisor and you won’t whine about the little things.


  • Nurseb911 March 7, 2009, 9:36 pm

    Anon #2: I can understand your first point, but cost (fees, commissions, taxes) make a significant difference in the long-term returns of investments.

    I would be interested in hearing about how your advisor saves you “10 times more tax” each year – if possible shoot me an email and I’ll be more than happy to present the other side of the argument from your perspective.

  • Anonymous April 9, 2009, 9:13 pm

    Mutual funds give people a low cost alternative to investing in the markets. Those that are on this post are clearly in a different class, yet the vast majority are average people then to save for their future in a prudent and well managed way. With the priveledge of this professional management comes expert advice, and all of this comes at a cost. Research has consistently shown that those investors that use financial advisors fare 3% better on average than those investors then don’t use professional counsel.

    Just my two cents.

  • Nurseb911 April 10, 2009, 7:35 am

    Anon – mutual funds “can” give an investor a low cost alternatives to investing in equity markets vs. straight equity (stock) investing, but the vast majority of people aren’t aware of all the costs associated with investing via professional management. Don’t you think that clearly presents a serious conflict of interest?

    As for your 3% claim I would like to see the study/research that provided that claim. There are a number of studies that demonstrate that a passive approach (index investing) without any professional guidance outperforms professionally managed mutual funds over the long-term. There will be individuals (such as Buffett, Cundill, etc) who consistently outperform, but that is not the norm.

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