Mutual Funds Mauled by the Bear Market? It Gets Worse…

Toronto, ONSo your mutual funds are way down, and your losses are mounting. You're even considering the services of a lawyer, because you suspect some shenanigans on the part of your fund manager who wasn't looking out for your best interests, leaving you poised to file a mutual fund ERISA claim. Had he managed the funds more prudently, your mutual fund losses might not be so pronounced.

Oh, but it gets worse. Read the fine print in that prospectus—if it's even in the fine print at all.

That's because if you decide that enough is enough, and you want to bail on your funds, you may have to pay a redemption fee. And here's the best part: that fee may be based on the original amount of your investment, not on the pitiful figure to which your portfolio has dropped. Thus, your loss is even bigger.

Grab a crying towel, we know you have several…

There is little doubt that mutual funds have taken a double-barreled hit, thanks to the bear that's been rampaging the stock markets over the last year. That's a generalized term—all funds, no matter how prudently managed, have felt the sting of the bear.

Beyond that, there have been various funds accused of mismanagement. Losses incurred by the Neuberger Berman funds, and the Causeway fund, are thought to have been enhanced by fund managers not acting with the best interests of their investors at heart. Were that to be true, fund managers would have violated the provisions of ERISA (1974, as amended) and the fiduciary duty that is their responsibility in the complex world of managing other people's money.

Many investors who have seen their portfolios decline beyond the overall drop of the market, due primarily to questionable investment decisions and allowing the funds to be dangerously exposed to faltering sectors, are filing mutual fund ERISA claims in an attempt to recover losses.

However, beyond that is the simple fact that the market is down—way down—and investors without the risk tolerance, or the time in years to wait it all out, are looking at getting out.

Well it seems getting out can cost you, and even more than you might have anticipated.

Don't Cry for the Mutual Fund Companies

For example, if an investor purchased funds with a deferred sales charge (DSC) then a redemption fee is required, depending upon how long you have owned the fund. The Globe and Mail reports this morning that Fidelity requires a redemption fee of 6 percent if redeemed in the first year, with a descending fee schedule according to the number of years you have held the funds. At year six, the redemption fee is zero.

However, one wonders how many investors noted, or were told this little tidbit:

"The charge is based on the original cost of your units."

Translated, that means you're paying the redemption fee based on the original, and potentially robust value of the mutual funds when you acquired them—not the deflated value they represent today. Of course, you're only charged a fee based on the actual number of units you redeem, but you get the point.

Take this example cited in the Globe and Mail. An investor plunks down $10,000 into AGF Canadian Large Cap Dividend-Classic January 1st of this year. By December 2nd the value had dropped 36.5 percent. You can't take it any longer, your blood pressure has reached its peak and you've just got to cut your losses and run. Your hard-earned $10K has, in a year, fallen to just over $6K. You've just witnessed $3,650 vanish into thin air.

Trouble is, you're about to lose another $550. That's because the redemption fee of 5.5 percent, which is duly noted in the AGF prospectus, is applied against the original $10,000—not the current value of $6,350. You lose another 8.7 percent. What's more, when combined with the overall drop in value, you've done worse than the 40 percent plunge overall in the S&P/TSX composite index over the same period.

You lose twice.

"I think it's worthwhile preparing people," said Garth Rustand, the Investors-Aid Co-operative of Canada's executive director, in comments published by the Globe and Mail's Report on Business. "Most don't know that if they lose their job and they're
trying to access cash, they may have to pay a redemption cost on the original cost of their investment, rather than the current value."

He goes on to say that while mutual fund companies disclose all of their fees in prospectus documents, it is unclear in some cases whether those fees are charged on the current value—a much lower value in this market—or based on the original investment.

"The information is certainly not mentioned in a prominent way," he says.

There is little doubt that mutual funds are hurting, and even the best-managed funds have been hit by substantial mutual fund losses in this rampaging bear market. Poorly managed funds are also open to mutual fund erisa claims on the part of angry investors. However, in the end it's the investor who loses more, and it is the investor who could pay substantial redemption fees based on original value, and not market value, who loses the most.

Especially, if that little tidbit wasn't mentioned at point of sale. What's your lawyer's number again?