Should You Breakup With Your Mutual Fund Manager?

“Invest for the long term” is a great maxim to live by. That means when you pick a mutual fund, you should be hoping for a fruitful long-term relationship rather than an ill-advised one-night (or one-quarter) stand.

Nonetheless, even great relationships might end. Here are four warning signs that a breakup might be on the horizon:

#1: Style Drift

Many mutual funds are characterized by an investing “style,” or core philosophy. Value funds, for example, are led by managers who “bargain-hunt” for solid, undervalued companies. Growth funds, in contrast, are led by managers who search for the “next big thing.” Both growth and value investors expect that their mutual fund managers adhere to their preferred style.

“Style drift” happens when style managers stray outside their core investment philosophy. This often happens when a particular style becomes unfashionable over shorter cyclical periods. During the 1990s dot-com boom, many value investors drifted towards the siren call of rapid-growth tech stocks like Pets.com. Disciplined value managers who stayed the course eventually got the last laugh.

If your fund manager is susceptible to “style drift,” it might be time to search for a new relationship.

#2: Asset Bloat

Mutual fund managers make more money when they have more assets under management. That’s a simple, immutable fact of life. If you charge a one percent management fee, you’ll earn $1 million for managing $100 million. You’ll earn $10 million for managing $1 billion. The incremental additional overhead to manage $100 million vs. $1 billion is negligible, which means most of your added revenue falls to the bottom line.

There’s nothing wrong with that formula, as long as the manager still provides solid service. But at some point, those additional dollars may overwhelm the actual availability of prudent investment opportunities for the fund’s strategy.

Good managers usually know when it is time to close a fund to new investment. (Existing investors will often retain ongoing rights to purchase new shares in the closed fund for some period of time). They forego the temptation of asset bloat because they know it will better serve their existing investors. These are the managers you want to keep around.

#3: Fee Creep

Understanding the arcane structure of mutual fund fees is an ongoing frustration. At the outset, its hard to tell whether Manager X deserves to be paid 1.2 percent when his peer group average fee is one percent. Only time, and performance results, will tell.

But watch out for fees that creep upwards for no apparent reason. Management fees are used to pay for the overhead of running the fund. Periodic fee increases could be signs of a lack of stability at the management company, especially if there does not seem to be any clear performance-related reason why you should be paying more. That’s something you will want to avoid when the problems eventually boil over.

#4: Ethical Transgressions

Perhaps most importantly, pay close attention to your fund manager’s ethical track record. Many smart investors got burned by Bernie Madoff. Fortunately, SEC-regulated mutual funds are required to disclose regulatory violations on their public documents. Periodically checking these (which you can do by simply calling a client service representative at the fund) can help you stay in the loop about whether the managers are keeping their noses clean. As the old maxim goes, trust … but verify.

Are you thinking about breaking up with your mutual fund manager? Share your story in the comments.