While working on the white paper featured in the "Exclusively for Members" section of our FiduciaryNews.com monthly newsletter, I trolled the internet to see if I had missed any peer-reviewed research papers on the subject of mutual fund conflict-of-interest. Admittedly, there have been many and I've reported on quite a few of them, but, scientist that I am, I always suspect there remains at least one stone unturned. And I was right.
And what a rock of insight it was. Here was an academic paper – as far as I can tell not published anywhere – by a couple of professors from the least likely places: Iowa and Australia. This conflict-of-interest is so hidden, the two authors had to construct their own metric to identify it. And here's the most amazing part – the data they used did not come from the fund prospectus, its Statement of Additional Information or, indeed, any other fund document. Instead, they found it in several of the standard questions on the FORM ADV of the fund's investment adviser. For the full story on the issue – called "cross trading" – including comments from one of the authors of the paper, read "New 401k Plan Sponsor Fiduciary Worry: Study Reveals Previously Unpublicized Conflict of Interest Can Harm Mutual Fund Performance" (FiduciaryNews.com, April 1, 2014).
My point is this. The paper has a date of February 28, 2014. The University of Iowa, where one of the authors resides, has a press release on it (which is how I found it in Google). This paper has a really salient point on an underreported technically legal (aren't they all) mutual fund conflict-of-interest. Their research shows investors, in the worst case, can lose 1% per year in investment performance as a direct result of cross trading. And yet, not an ounce of ink has been spilled over it.
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Compare that to the barrels of black stuff (including black pixels) that gushed forth on the non-revelations of the recent Ayres/Curtis "paper," much of that wasted on the "high mutual fund fees" digression and precious little on the paper's main point, which fundamentally is a legal challenge. Here we have one paper (Ayres/Curtis) discussing arcane legal interpretations – essentially, how to make a case if such a case existing – and another paper (the one on cross trading) finding a previously undiscovered smoking gun and providing the empirical evidence of its direct guilt in causing lower fees.
So why haven't we heard or seen this cross trading "scandal" blaring in headlines and across our screens? No, instead we get a 60 Minutes report about how the house is rigged for short-term traders. Short-term traders? Geez Louise. They deserve what they get. The so-called "rigging" of Wall Street doesn't really impact disciplined long-term investors. Heck, the whole thing about "disciplined" is a willingness to leave money on the table.
But a willingness to leave money on the table is not the same as tolerating a pick pocket – which is what cross trading comes down to when you really think about it. It's a legal right that's not disclosed in the mutual fund literature to engage in self-dealing. Normally, in a perfect fiduciary world, this would be a prohibited transaction. But in today's universe of dual registration, it's become the norm.
Are you willing to give up 1% a year in performance for no reason? Yes, there may be some (other than the broker) who benefit from cross-trading, but it's a zero-sum game. For every client that benefits, another client loses. (Hmm, doesn't that occur in a Ponzi Scheme, too?) Are you willing to be the client that loses? In exchange for nothing?
Next time some reporter comes calling about "high fees," remind them it's not the "high" fees, it's the "hidden" fees.
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Christopher Carosa
Chris Carosa has been writing a weekly article and monthly column for BenefitsPRO online and BenefitsPRO Magazine since 2011 and is a nationally recognized award-winning writer, researcher and speaker. He’s written seven books, including From Cradle to Retire: The Child IRA; Hey! What’s My Number? – How to Increase the Odds You Will Retire in Comfort; A Pizza The Action: Everything I Ever Learned About Business I Learned By Working in a Pizza Stand at the Erie County Fair; and the widely acclaimed 401(k) Fiduciary Solutions. Carosa is also Chief Contributing Editor of the authoritative trade journal FiduciaryNews.com and publisher of the Mendon-Honeoye Falls-Lima Sentinel, a weekly community newspaper he founded in 1989. Currently serving as President of the National Society of Newspaper Columnists and with more than 1,000 articles published in various publications, he appears regularly in the national media. A “parallel” entrepreneur, he actively runs a handful of businesses, including a small boutique investment adviser, providing hands-on experience for his writing. A trained astrophysicist, he also holds an MBA and has been designated a Certified Trust and Financial Advisor. Share your thoughts and story ideas with him through Facebook (https://www.facebook.com/christophercarosa/)and Twitter (https://twitter.com/ChrisCarosa).
