Funds Exists for AUM Fees? Two Examples

Closed End Funds (CEF) are very similar to mutual funds with 1%+ of expenses, and many are actively managed. The difference lies in trading and not able to create new units. When I started investing few years back, in income domain, I was attracted by high yields. While I got rid of quite a few CEFs, I still continue to hold IIA, IGD, and AOD.

Among others, one of the issue with these funds (for which I get annoyed) is the way the fund managers drift away from objectives and execution strategies. Investors continue to remain invested under the impression that fund managers are continuing to stick to the originally stated objectives. Furthermore, there is nobody to question these managers. The whole premise of using actively managed funds (including CEFs) is that managers will keep up original objectives and use their skills for reducing downside risk. Let me discuss two examples:

• AOD: Originally, one of the objectives of the fund was to look for best dividend opportunities around the globe. In doing this, it will focus on dividend income and long-term growth of capital. When I had bought the fund, it had approximately 65% invested in international companies (i.e. Europe, Asia, South America, Australia, etc). As the downturn began, in my opinion, the fund managers fail to grasp or anticipate the potential risk to its funds. Dividends have been reduced continuously. In addition, the funds underwent changes. The fund drifted and now has 50%+ of US investments. As other growth or emerging markets recovered, AOD missed the bus, because its most of the holdings were in US. Basically, fund managers were getting paid for continuously destroying capital since its inception.

• IIA: This is one my buys from yield chasing days. The fund focus was to invest in US REITs and provide regular monthly income. With the downturn, this fund was almost a toast. Dividends became a trickle. And now the fund has been merged with another fund IGR (with similar objectives but for global market). The notion that nobody saw it coming does not justify the failure. The capital destruction was to such an extent that IIA could not sustain itself. The fund house merged it with another fund IGR. Here, also, the fund manager kept getting paid to destroy their investor’s capital.

The point is as individual investors, we just do not have visibility into the funds operations. The use of “return of capital” get diluted to income yield or dividend or distribution for marketing purpose. In reality, these managers are doing nothing but, giving your money back. This is another reason to invest in ETF (instead of CEFs) which are following certain index and are likely to stick to it.

In short, these funds exists for the purpose of paying Assets Under Management Fees (AUM) to the advisor, and not for maximizing shareholder value or income. I will get fired with such continued non-performance, but not these fund managers. On original cost basis, these two funds combine occupy close to 1%, while on present value basis it is less than 0.4%. Getting rid of them will not move a digit in my portfolio, but holding them reminds me what not to do in future.

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