Definition of "Net of All Fees"

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Alskar
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Definition of "Net of All Fees"

Post by Alskar » Sun Sep 29, 2013 4:49 pm

I hope this is the correct place to post this question. I couldn't decide if this was a "personal" question or a "theory" question. Please move it to the correct forum if I have it wrong.

Background: My 87 year old father and my brother both use the same Ameriprise "Financial Planner" who is really a broker-dealer with CFP certification. Despite the fact that he charges 2% of AuM as a so-called "wrap fee"; charges large commissions on the insurance products he sells them, and puts them in mutual funds with large (3.00 - 4.75%) loads they are both THRILLED with him. To keep the peace in the family I agreed to talk to him about my finances about five years ago. After our 2 hour phone call I was more disturbed than ever by his dubious honesty and misleading statements. After much soul-searching I decided that I had nothing to gain and everything to lose by getting into a debate with my father and brother about this. They both truly believe that this guy (whom I will call "Bobby") regularly "beats the market". At the time I didn't see how I could overcome their zeal and I'd rather have cordial relationships with my father and brother than be right about Bobby so I've kept my mouth shut and politely changed the subject when those two start waxing enthusiast about Bobby's brilliance. For the record, I believe Bobby belongs in jail. His shenanigans after my mother's death literally made me sick to my stomach. So far I have kept my strong opinions to myself.

However, my brother recently went on an extended trip (he retired at 50) for several months. In his absence, I was given PoA for my father and access to his financial records. Some of the things I found while helping him after the sale of his house are literally keeping me up at night. This brings me to my question:

Since I've never purchased a mutual fund with any kind of load, I would like to understand how performance is calculated on a fund with a load. For example, if I put $100K into a fund with a 5% front-end load is the performance calculated based on the original $100K or is in based on the actual $95K that actually got invested?

Similarly, with a back-end load: If the fund has a 1% CDSC (Contigent Deferred Sales Charge) does the performance data reflect this 1% back-end cost?

I am basically wanting to be educated as to how Bobby is able to convince both my father and my brother (both highly educated engineers) that he regularly "beats the market". He claimed to me that the performance data he shared with me was "net of all fees". I'm a bit skeptical of that claim. Here's what I noticed in my conversation with him a few years ago:

1. He compared his performance against the raw Wilshire 5000 index (devoid of the dividends) during 2008 and 2009 despite the fact that his example portfolio contained a significant proportion of bonds. In essence, he was comparing an all-equity index devoid of dividends to a portfolio that included 40% bonds and included dividends. This trick made him look really good in comparison during that time period.

2. He ignored tax consequences of his frequent trading. The tax cost is heaped on my my father and brother's tax bill but is not reflected in his performance data.

3. Some of the funds he recommended had huge 12b-1 fees. He wouldn't or couldn't say how much of these so-called "Revenue Sharing" or "Marketing" fees was coming his way.

Now I'm wondering if he is also playing games with the front and back-end loads. He could be doing pretty well if he didn't include the loads. How would I know?

What does "net of all fees" mean in the real world? Are there any other tricks that "financial planners" play to make their results look better than they really are?
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umfundi
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Re: Definition of "Net of All Fees"

Post by umfundi » Sun Sep 29, 2013 5:11 pm

Alskar,

Good luck. I hope the bridges you burn are with Bobby, not your family.

I suggest you simply make a spreadsheet of the history of the account's total value Include investments and withdrawals, but ignore all the churning. Then use something like the Excel function XIRR to calculate the rate of return. Compare that to a relevant index such as the S&P 500 or a fund like VSMGX which is 60/40 stocks/bonds.

Here are some tricks:

Survivorship bias: Funds disappear. Companies merge poor performers with other funds. The history of the bad fund disappears. Really, you cannot search its historical performance any more.

Window dressing: Buy investments after they have gone up. Then tell the client they own these high-performing gems, neglecting to say "since yesterday".

You might ask your father and brother, aside from what Bobby tells you, how do you measure the return on your investments? Then challenge them to actually do the calculation. But, I think the overall account balance should be evidence enough.

Good luck,

Keith
Déjà Vu is not a prediction

RonF
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Re: Definition of "Net of All Fees"

Post by RonF » Sun Sep 29, 2013 5:52 pm

I have experienced first-hand how a slick-talking, extremely personable financial planner can dupe one out of tens of thousands of dollars. My wife and I had about $725,000 in our IRAs as of early 2009 with a diversified portfolio of stocks and bonds. The portfolio is currently worth about $900,000.

Earlier this year, I began to wonder about the obvious underperformance. The market has more than doubled since early 2009 yet my portfolio (around 55 percent bonds and 45 percent stocks), had only increased from $725,000 to $900,000 in that time. In meetings with my financial planner, he always said the right things. The funds in the portfolio seemed reasonable. He would always point out how many of the funds had beat the market. His advisor fees seemed reasonable (around 0.9 percent of assets per year).

Then I decided to go through my quarterly statements from the last few years. I was absolutely horrified at what I found. Asset sales/purchases totaled $100,000-150,000 per quarter over the past 24 months (without any changes in our investment strategy). All purchases were of funds with a 5.0-5.9 percent load with 1.0-1.6 percent annual management fees. Based on the number of asset sale purchases, I estimated "load" payments of nearly $50,000 in the past two years. It makes me sick to my stomach knowing that this guy has been taking my money for the past decade. IMO, there should be some sort of law to prevent this sort of practice.

MIretired
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Re: Definition of "Net of All Fees"

Post by MIretired » Sun Sep 29, 2013 6:09 pm

A sensitive situation with your family. Usually your parents, or brothers, 'know' more.
Net of fees should mean after fees. Or the gains after fees. But, verbally the advisor telling you that does not mean much.
http://en.wikipedia.org/wiki/Investment_performance
Another distinction is between net and gross return. The 'pure' net return to the investor is the return net of all fees, expenses, and taxes, whereas the 'pure' gross return is the return before all fees, expenses, and taxes. Various variations between these two extremes exist. Which return one looks at depends on what one is trying to measure. For example, if one wishes to measure the ability of an investment manager to add value, then the return net of transaction expenses, but gross of all other fees, expenses, and taxes is an appropriate measure to look at since fees, expenses, and taxes other than transaction expenses are often outside the control of the investment manager.
http://www.hedgeco.net/hedgeducation/Wh ... e-faq5.htm
Are hedge fund returns reported before or after fees?

Most funds report their returns from previous years "net of all fees." This means net of management fees and net of incentive/performance fees. However, don't assume this; look carefully and if you are not sure, ask. Some funds report gross returns or returns net of management fees but gross of incentive /performance fees. Still others will report audited net of all fees returns with estimated/pre-audited net of all fees performance for the current year's performance. But regardless of which method is used, almost all funds state that their pre-audit figures are subject to adjustment by the partnership's auditor after the end of the year. These adjustments are almost always minor. If the adjustments are large, you should look for an awfully good explanation.
This was a common way to invest in the past. The internet advice for self-directed investing and with index funds is used a lot these days. But this requires a little understanding and sophistication on an investor's part. Albeit, quite a little with a little knowledge.
Advisors provide a service, though, to someone not willing to take it on themselves, or, who believe in the advisor.

But, if you get an asset allocation from a annual summary, or the advisor: you could substitute their return with a combination of, at minimum, equal to HIS portions of total U.S, stock market, total international stock market, and total U.S. bond market.

But, it might be hard convincing someone who absolutely 'loves' their advisor/planner.

Edit: Ditto Ronf. I have a lot of stories concerning sales tactics. Did you see the old movie, "The Music Man"?

OP: there are very many 'cues' of very bad things you mentioned. Wrap FEE? Funds have their own fees already. He gets some front load fees, 12b1 (back load fees), etc?

dbltrbl
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Re: Definition of "Net of All Fees"

Post by dbltrbl » Sun Sep 29, 2013 8:22 pm

Can you ask 'Bobby" to give your Dad in writing what his personal rate of return is for past 1, 3 and 5 years? You have POA so use it while brother is away. If they refuse its a cause for concern. If they provide, you have dta to share with your brother. Sometimes educated people are the worst to convince. They assume honesty and logical reasoning that some one spending 8 hours a day in industry must be good. Hard to change that mind set. Good Wishes.

pkcrafter
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Re: Definition of "Net of All Fees"

Post by pkcrafter » Sun Sep 29, 2013 9:01 pm

Are you absolutely sure this advisor is a CFP? If he is he's supposed to carry fiduciary duty to his clients, clearly he is not. Double charging--AUM fee plus loads? You must make sure the loads are not waived, which is common when assets are under management.

Front end loads (A shares), if charged, are removed before the remainder of the money is invested, which means returns do not reflected in the load. Instead of seeing NAV of a fund, the investment is shown with "market price" or some other misleading title which makes it appear the entire amount of money has been invested. A shares usually also have reduced commission based on larger amounts invested.

Back end loads also do not reflect performance. The amount of the load usually gets reduced for about 6-7 years and then the B share class converts to A. No additional load, and expenses are lower. Of course this doesn't work if the funds get dropped for new ones.

C shares (imbedded 12b-1 fees of 0.5-1%) are the most evil because they are ongoing and make the expense ratio extremely high. These can't be hidden, although most average investors would not even be aware of the fees, but the performance of C shares to other load classes will lag do to the high expense.

The performance comparisons you mentioned are down right devious.

If this guy is a CFP, he should be reported. It would be great if that was the end of the story, but it's not. The end of the story is there is nothing you should do about this advisor other than inform your brother. I'm sure that won't do anything but cause bad relations, and that's the end of the story.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

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Alskar
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Re: Definition of "Net of All Fees"

Post by Alskar » Mon Sep 30, 2013 7:39 pm

pkcrafter wrote:Are you absolutely sure this advisor is a CFP? If he is he's supposed to carry fiduciary duty to his clients, clearly he is not. Double charging--AUM fee plus loads? You must make sure the loads are not waived, which is common when assets are under management.

Front end loads (A shares), if charged, are removed before the remainder of the money is invested, which means returns do not reflected in the load. Instead of seeing NAV of a fund, the investment is shown with "market price" or some other misleading title which makes it appear the entire amount of money has been invested. A shares usually also have reduced commission based on larger amounts invested.

Back end loads also do not reflect performance. The amount of the load usually gets reduced for about 6-7 years and then the B share class converts to A. No additional load, and expenses are lower. Of course this doesn't work if the funds get dropped for new ones.

C shares (imbedded 12b-1 fees of 0.5-1%) are the most evil because they are ongoing and make the expense ratio extremely high. These can't be hidden, although most average investors would not even be aware of the fees, but the performance of C shares to other load classes will lag do to the high expense.

The performance comparisons you mentioned are down right devious.

If this guy is a CFP, he should be reported. It would be great if that was the end of the story, but it's not. The end of the story is there is nothing you should do about this advisor other than inform your brother. I'm sure that won't do anything but cause bad relations, and that's the end of the story.

Paul
Paul,

Thanks for your detailed reply. I am in your debt.

It took several hours of digging, but I finally found this statement in the pile of Ameriprise documents: "If purchasing mutual funds through a fee-based investment advisory account, the above sales charges (front- or bank-load) do not apply, although you will pay an annual asset-based fee (as described in the account overview section)." So it appears that the loads are waived. That's a huge relief. Thanks for the heads up!

I verified that "Bobby" has his CFP certification by checking on the CFP website. He has no disputes listed on the CFP website. He has two disputes listed on the FINRA Broker Check website. Both disputes were resolved in his favor.

I was unware that CFP's are supposed to uphold "the duty of care of a fiduciary as defined by the CFP Board". It is very difficult to see how a 2% wrap fee and a junk bond fund (Columbia High Yield Bond Fund, INEAX) is consistent with a fiduciary standard but I I know "fiduciary" means nothing these days.

For whatever its worth, I think misleading comparisons are pretty par-for-the-course these days in all financial matters. For example, I have yet to participate in a 401(k) plan that is being run for the benefit of the employees despite the fact that the ERISA requires this to be the case. Part of the reason that my brother and my father don't believe what I tell them is simply because if what I'm telling them is true then it must mean that the whole financial system is rigged and they can't accept that so clearly what I'm telling them about Bobby can't be right.
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pkcrafter
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Re: Definition of "Net of All Fees"

Post by pkcrafter » Mon Sep 30, 2013 8:09 pm

Alskar, here's the Fiduciary Oath for you own information.

http://www.napfa.org/about/FiduciaryOath.asp

The key element in the oath is "in the clients best interest." If you found any C share funds with ongoing loads, then a case may be made that the advisor is violating his oath.

Brokers are only held to the "Suitability Rule", which is almost meaningless.

Paul
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Alskar
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Re: Definition of "Net of All Fees"

Post by Alskar » Thu Oct 03, 2013 12:41 pm

pkcrafter wrote:Alskar, here's the Fiduciary Oath for you own information.

http://www.napfa.org/about/FiduciaryOath.asp

The key element in the oath is "in the clients best interest." If you found any C share funds with ongoing loads, then a case may be made that the advisor is violating his oath.

Brokers are only held to the "Suitability Rule", which is almost meaningless.

Paul
Hi Paul,

I'm familiar with the NAPFA oath, but I'm not certain this definition applies to "Bobby". Bobby is a broker-dealer with Ameriprise and a CFP certified "financial planner". As you pointed out, as a broker-dealer, Bobby is only held to a "suitability" standard, but as a CFP certified professional he is supposed to live up to a "...the duty of care of a fiduciary..." Here's a link to a description of what the CFP organization means by this statement: http://www.cfp.net/for-cfp-professional ... ciary-duty.

After having read all of this, I'm still not sure what the CFP organization requires of their financial planning professionals. Is putting the bulk of an 87 year old's retirement assets in a junk bond fund (INEAX in this case) in the client's best interest? Here's a quote from the prospectus for INEAX: "Under normal market conditions, the Fund invests at least 80% of its net assets (including the amount of any borrowings for investment purposes) in high-yield debt instruments (commonly referred to as "junk" bonds or securities). These high yield debt instruments include corporate debt securities as well as floating rate loans rated below investment grade by a nationally recognized statistical rating organization, or if unrated, determined to be comparable quality." For the record, my father (the 87 year old in question) has plenty of money and does NOT need to take on this much risk. I'm 52 and I don't have any junk bonds in my portfolio. So I conclude based on my values that this investment is neither "suitable" or consistent with "...the duty of care of a fiduciary...", but I bet I'd lose that argument with Bobby and the CFP board.

The issue gets even murkier when one considers active vs passive management. I personally don't believe that active management is consistent with "...the duty of care of a fiduciary..." I believe this based on the preponderance of academic studies that clearly show that active management does not work. However, there is an entire industry that has at its core a belief that active management works. So can one live up to a fiduciary standard while recommending actively managed funds? I say no, but I bet the majority would say yes.

My point: The fiduciary standard of care is poorly defined and is highly subjective. I think my father and brother are getting badly ripped off, but I doubt there is much I can do about it. When I read the descriptions of the two "disputes" listed for "Bobby" on the FINRA website it seems that as long as Bobby properly discloses the risks, then he's covered. I find it interesting that both disputes were initiated through FINRA instead of the CFP board. If I was going to initiate a dispute with Bobby I would definitely chose the CFP Board over FINRA.

It's a mess out there!
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