Index funds never lose their managers

If Larry Sarbit had announced his departure from AIC Limited tomorrow, investors would have brushed it off as an April Fool's prank.

Coming earlier in the week, however, the sudden departure of yet another high-profile mutual fund manager from a multi-billion dollar fund merely increases the frustration of believers in actively managed mutual funds.

I never bought the AIC American Focus Fund but wrote about it and interviewed Sarbit often enough to feel for the unitholders who did.

Sarbit always waxed eloquent about how the U.S. stock market was overvalued and how he couldn't bring himself to spend unitholders' hard-earned money on overvalued securities. Rather than join the herd and dump his $2-billion into whatever stocks were available, Sarbit stuck to his deep value guns. He displayed an admirable fiduciary attitude to the money entrusted to him. As a result, the fund was notoriously mostly in cash for most of its five-year existence.

Sarbit is not the only manager to leave unitholders in the lurch lately. C.I. Funds recently lost the services of income trust ace Ben Cheng. Given how hot income trusts are, you can be sure others with hot hands in the sector will soon follow suit.

It's maddening to hear the fund industry preach buy-and-hold to customers who are more committed to holding their funds than their managers. In the case of Trimark Fund, long-suffering unitholders suffered the departure of Bill Kanko twice!

Sadly, this is standard procedure. Ask the Altamira investors who loved Frank Mersch in the 1990s or the AGF and Fidelity investors Veronika Hirsch loved and left in the blink of an eye. Or the Templeton Growth Fund investors who felt secure in the fact Mark Holowesko learned his craft at the knee of Sir John himself. Or the investors who entrusted almost $10-billion to Charles Brandes at AGF.

Fund industry consultant Dan Richards lists a dozen other examples of prominent managers who have played the game of fund musical chairs: Gerry Coleman, Jerry Javasky, John Zechner, Dina DeGeer, Dennis Starritt, Richard Whiting, Kiki Delaney, Jonathan Wellum, Kim Shannon, Keith Graham, John Embry and Rohit Segal.

Richards, president of Strategic Imperatives, sees two factors at work. Sometimes, managers feel they won't be recognized if they operate in the shadow of established, high-profile managers. Often, though, "it's all about the money. A manager who has built up a track record and a following among advisors can attract significant assets to a new firm --and can command hefty compensation as a result."

But investors can learn from this. One is to avoid funds sold with a Deferred Sales Charge (DSC), since you don't want to be locked for seven or eight years in funds where managers are long gone. That way, you can move with managers to their new firms, assuming there are no capital gains tax consequences.

Investors should also be cautious about buying "lone wolf" managers who don't have strong teams behind them, Richards says.

Generally, a money manager's record can be 70% attributed to the firm and only 30% to the individual, says fund analyst Dan Hallett.

"It's inevitable that money managers will be mobile," Hallett says. "They either get fed up with their working environment, get more lucrative offers or simply desire the challenges that come with change. And sometimes, they just retire. It's the reality of life. These managers are human."

It's precisely because of such all-too-human foibles that many investors embrace passively managed index funds or exchange-traded funds. It's questionable if active fund managers can consistently earn back their fees; even their good trades generate taxable activity in non-registered accounts. So why not forget about active management altogether and buy the market? Costs are lower, there are fewer taxes and you don't have to worry about hot fund managers leaving you stranded.

Tomorrow has been designated Index Funds Day in the United States. "April Fool's Day will be the ideal time to draw attention to the differences between active investment management and indexing -- and why it's a fool's game to think one can outperform the market averages," says Mark Hebner, president of Index Funds Advisors (www.ifa.com).

Hebner says active managers perpetrate a "harmful hoax" on investors on April 1st and every other day. Most stock brokerage firms, actively managed mutual fund firms and financial advisors "do not understand the randomness and efficiency of markets."

Tomorrow, you can turn the tables. Tell your advisor you're switching all your active funds to their index equivalents. Wait a second for the reaction before adding "April Fool's."