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Mutual Fund Merry Go-Round - Part Two:
Selecting The Right Advisor

FORECASTS & TRENDS E-LETTER
By Gary D. Halbert
July 11, 2006

IN THIS ISSUE:

1.  The Case For Professional Money Management

2.  Which Type Of Advisor Is Best For You?

3.  Sources of Advisor Information

4.  The Advisor Evaluation Checklist 

5.  Conclusions

Introduction

In the first half of my discussion of the “Mutual Fund Merry Go-Round” in my June 20 E-Letter, I discussed how investors hurt their own long-term returns by jumping from one hot fund to another.  This has been well documented in studies conducted by Dalbar, Inc., a Boston-based market research organization. 

In that same E-Letter, I discussed several different ways to try to keep from being a “Dalbar statistic,” including mutual fund rating services, newsletters, hotlines, Internet resources, etc.  I also discussed some of the tricks that can be pulled by unscrupulous “experts” whose primary purpose is to separate you from your money.

In this second half of this series, I’ll discuss why I think you should utilize professional money managers, and how to find the right Advisor for your situation.  The question is, how can an individual investor find the truly successful professional money managers?  In the remainder of this E-Letter, I’ll address ways to help you separate the superior Advisors from all of the others out there.

Why You Need Professional Money Managers On Your Team

Since the beginning of the Forecast & Trends E-Letter, I have consistently stated that I believe most investors should have professionals managing a good portion of their money.  I believe this for many reasons, but for sake of brevity I will mention just four.  First, a top-tier professional is usually far more knowledgeable and skilled in investment management techniques than the average investor.  That is not to say that you are incapable of learning this information, just that you have probably not taken the considerable time required to do so. 

Second, the professional manager usually has more access to investment information than you do.  You may think that the Internet has changed all of this, but it hasn’t really.  There is a lot of MIS-information on the Internet, and you have to know how to tell the good from the bad.

Third, most successful Investment Advisors have a time-tested “system” which helps identify which market sectors to be in, and which generates most of the trading signals.  Also, most successful Investment Advisors have developed the discipline to follow their time-tested systems.

Finally, and perhaps most importantly, professional managers can help eliminate the emotion that most investors experience when making decisions.  In addition, they take the burden of money management away from you.  Most people reading this have a full-time job in addition to trying to make time to deal with their investments.  Even if you are retired, you probably have hobbies or pastimes and enjoy spending time with your family and friends.  Managing your own money takes a lot of time away from things you would rather be doing with your life.

Determining The Type Of Manager You Want

If you agree with me that professional management is the best way to go, then you have just begun your journey toward finding the best “fit” for your financial situation.  My advice to seek out professional money managers is of little use unless I provide some guidelines by which you can evaluate them.  The woods are full of Investment Advisors, both good and bad.  Knowing how to select the more successful ones is the key to success.

The first decision you need to make is what kind of professional money manager you want.  As I stated above, I recommended that you seek out only Registered Investment Advisors who are either nationally registered with the SEC or state-registered with your state’s securities regulatory agency.  Don’t settle for the first person you find who hangs out a shingle as an Advisor or financial planner. 

Though limiting your search to Registered Investment Advisors has narrowed the list down considerably, there are still thousands of potential managers from which to choose, each offering different types of services.  Some Advisors manage money for their clients, but have little day-to-day contact with them.  Others live in the same local area as their clients and seek a very close relationship with each one.  Between these two extremes are many variations. 

In this E-Letter, I am going to limit my comments to finding Advisors whose sole function is to manage money for their clients, usually on a long-distance basis.  I will also limit my discussion to money managers who utilize mutual funds or exchange-traded funds (ETFs) rather than individual stocks and bonds.  The reason is that those who use mutual funds and ETFs are usually able to accept lower minimum investments, and are thus available to many more individuals than those who manage individual stocks and bonds with higher minimum investments. 

Finally, my comments will be limited to those professionals who practice “active management” techniques.  This means they have the flexibility to move among market sectors as needed, or even from investments to cash when market conditions merit.  Virtually any broker or financial planner can fix you up with a portfolio of mutual funds to buy and hold.  Successful active managers, however, can potentially add value by reducing the risk of being in the markets at all times.   With today’s volatile markets, I believe it is imperative to have a money manager who can move you to cash or hedge long positions when market conditions merit.

Though I am limiting my discussion to active managers, much of this same selection and due diligence advice can be used in relation to any type of money manager, including your own broker. 

Where to Find Advisors 

Unlike mutual funds, Advisors are not required to release their performance information to any exchange or third-party reporting service.  Even the SEC does not publish a list of all Advisors.  Therefore, it is difficult to find a single database that carries performance information on every Advisor available.  You hope to be able to find a database or service that covers as many Advisors as possible, but there will still be very good money managers who do not report to these services.  Quite often, word-of-mouth is the most effective way to find a superior Advisor.

In response to the demand for independent professional money managers, various firms now offer access to Advisor performance information.  In addition, these firms also provide software that allows you to search and analyze the performance data more efficiently.  While there are many firms that provide these services, I’ll list those that I consider to be the three main players below:

1.     Informa Investment Solutions Software

Informa’s website, http://www.informais.com offers a free listing of the over 1,600 money managers in their Plan Sponsor Network (PSN) database.  However, you must register to obtain this information.  The cost of the analysis software starts at $3,000 per year, and goes up from there depending upon the modules you select.  Phone: (914) 509-1576      

2.    Money Manager Review 

Money Manager Review’s (MMR’s) Internet-based Performance Database is one of the easier and more cost effective ways to search for an Advisor.   MMR’s database provides access to over 1,300 different programs offered by over 800 professional money managers.  Cost of the MSearch System is only $295.00 per year.  Website: http://www.managerreview.com/. Phone:  (415) 386-7111

3.     Morningstar

Usually viewed as only a mutual fund rating firm, Morningstar has branched out to include stocks and separate account Advisors in its “Principia” software application.   The “Separate Accounts Module” currently offers over 1,000 firms representing more than 5,000 programs.  Cost for the Separate Accounts Module alone is $635.00 per year, with additional modules for mutual funds, variable annuities and stocks available at additional costs.  Website:  http://corporate.morningstar.com/US/asp/subject.aspx?xmlfile=41.xml.  Phone: (866) 705-5551  

As you can see, accessing information about professional managers is not cheap.  However, the availability of these programs allows you to not only see the performance information, but also have the technical tools available to analyze and compare this data with various market benchmarks. 

While these software firms offer a wide variety of Advisors, they are by no means comprehensive in their coverage because participation by the money managers is on a voluntary basis.   In addition, most of the firms listed above do not include active managers.

One source for active managers is the MoniResearch Newsletter.  Steve Shellans, editor of the newsletter, provides long-term results and also assigns an “ulcer index” to each Advisor’s program, indicating how much volatility it is likely to have.  The cost for the MoniResearch Newsletter is $159 per year for six issues.  You can contact MoniResearch at P.O. Box 1907, Woodland, WA98674, or by phone at (800) 615-6664.

Another good source of active-management Advisors can be found on the Internet.  It is called Theta Research and canbe found at www.thetaresearch.com.  Subscriptions start out at $150 per year for individual investors.  However, it is important to remember with this large database that, just as in the investment study, the average Advisor’s performance is not very impressive.  In addition, many Advisors listed have short track records, so it’s important to focus on those with long-term results and not just one hot year.

(Note – I do not endorse any of these websites or software products, and I am not paid for any referrals.  Thorough due diligence should be conducted before any investment decisions are made.)

Advisor Evaluation Checklist

Once you find Advisors who meet your criteria, it is important to check them out.  Below you will find a basic list of factors that my firm uses when evaluating Advisors.  Space simply doesn’t permit me to list every single one of the factors that we consider with an Advisor, but this basic list will get you well on your way.

1.  Obtain The Track Record.  

While this sounds like a rather obvious place to start, it is important to not only get historical numbers, but also know how these numbers were generated.  When offered performance numbers, you have to ask questions, such as:  Are the numbers “real-time” experience by actual accounts, or “pro-forma” (hypothetical numbers based on “back-testing”)?   Are they a “composite” (average) of all accounts managed by the Advisor, or are they results from just a single account?  If from just a single account, is that account’s experience typical of others managed by the same Advisor?  Do the performance numbers represent gross returns before management fees were withdrawn, or are they net of all fees and expenses?  

Though Advisors are regulated by the SEC, there is still some flexibility as to how performance numbers are presented.  So, be sure to read the fine print as it may contain important disclosures regarding the performance numbers given.  Also, determine whether the money management system or technique used by the Advisor was consistent over the entire length of the track record presented.   If the system changed significantly in the past, any track record prior to that change may be meaningless.

Once you have “official” real-time performance numbers, then ask the Advisor if the performance record has been audited by an outside, independent accounting firm.  Obviously, independent verification of the performance record is desirable, but not all Advisors have audited numbers.  If that is the case, ask to review actual monthly statements from several randomly selected representative accounts.   This will allow you to see whether or not the actual results in the real accounts you review is the same as the track record claimed by the Advisor.  Be aware that it is common for individual accounts to be slightly different from the track record claimed by the Advisor, but they should be very close.

One last point on this.  Some Advisors will not agree to share client account statements with you.  They may tell you that their clients’ information is “confidential” and not available for inspection.  That is BUNK!  All they have to do is make copies and “white-out” the name and personal information.  A good Advisor will be happy to provide you with statements for representative clients.

2.  What Type Of System Is Used?  

Most active management Advisors use computer models and/or other types of proprietary systems to assist them in managing money.  These systems typically issue a buy or sell signal that the Advisor then trades upon.  While most Advisors will not show you every detail of their system for fear that you might try to copy it, they should be willing to describe in general whether it is based on analysis of market trends (trend-following systems), market momentum, money flow, market fundamentals, etc.

At this point it is also important to ask whether or not the Advisor ever uses his or her individual discretion to override the system.  Some Advisors will never override their systems, while others depend upon their own discretion to supplement the system output.  If discretion is used, ask to see several examples when discretion overrode the system, and look closely at the resulting performance.

I’ll give you fair warning, many Advisors have advanced degrees in engineering, mathematics, and/or computer science.  When you ask these very smart individuals to explain their system, you may get more than you bargained for.  Keep this in mind.

While I am talking about systems, it is also important to ask whether the Advisor constantly monitors and adjusts the system for changing market conditions.  Few active management systems developed in the 1980s or even 1990s work well today in their original form.   It is imperative that the Advisor continues to monitor the system and make any necessary adjustments for changes in the market environment.   Some Advisors actually have different modules, each designed for a specific market environment.

3.  Back-Office Support.  

Even the best of money management systems are of little use if accounts cannot be opened, monitored and traded effectively.  Thus, it is important that the Advisor have a “back-office” staff capable of handling the administrative tasks inherent in money management.  That is not to say that you should automatically disregard any one-man shop, but you should determine whether he or she can handle an influx of business.  Remember, if you have found this Advisor because of superior performance, others will too.

4.  Back-Up Plan?

This is an important question, and not just for one-man shops.  Even though an Advisory firm may have many employees, the “brains” of the operation is often just one or two people.   You need to know what would happen if the key person, or persons, dies suddenly or become incapacitated for a long period of time.  At the very least, the Advisor should have some plan to have all existing positions closed out and accounts taken to cash in the event of his or her death or incapacity.  If there are no contingency plans, it may be prudent to pass on that Advisor.

A similar situation exists when an Advisor is near retirement.  Ask the principal of the firm when he is planning to retire.  If he is planning to retire, has he been grooming an experienced replacement, and is the replacement completely knowledgeable about how the Advisor’s system works?

5.  Custody Of Funds.   

Most Advisors are precluded from taking direct custody of client funds.  Thus, they must retain a third party to hold the funds and execute mutual fund trades under the Advisor’s direction.  Some third-party custody sources include mutual fund companies, brokerage firms and trust companies.  Each type of custodian has its own unique advantages and disadvantages that are too lengthy to go into in this E-Letter.  My personal preference is to have funds held in a brokerage account, followed by a mutual fund company, and my third choice would be a trust company.

6.  Ongoing Communications.  

Ask what kind of communications the Advisor sends to clients.  Are statements monthly or quarterly?  Does the Advisor produce the statements, or are they prepared by a brokerage firm or third-party custodian?  For taxable accounts, it is important to know what kind of tax reporting is provided at the end of each year.

Many Advisors also provide monthly or quarterly newsletters.  All of these sources of communication help to keep you in touch with what is happening to your money.

7.  Regulatory History.  

As stated earlier, Registered Investment Advisors are regulated by the SEC or the state(s) in which they do business.  One SEC requirement is that every Advisor provide a “Form ADV, Part II” to each potential client.  This document contains comprehensive information about the background of the Advisor and its principals, how the Advisor does business, and any past regulatory problems.

If there have been regulatory problems in the past, you want to find out specifics.  Regulators have become increasingly scrutinous in recent years, and some of the things the regulators cite as being violations can be minor.  There are also situations where regulatory violations had extenuating circumstances or were the result of a “rogue” employee who is no longer with the firm.  At the very least, you should question any past regulatory problems diligently.  Any credible Advisor will understand your concern and provide a complete explanation.  An Advisor who becomes too defensive should be avoided.

You can also access a registered Advisor’s regulatory history on the SEC’s website at www.sec.gov.  You can search this site by the firm’s name or by its “CRD number” (a unique registration number issued by the SEC).  Information about state-registered Advisors can be obtained from your state’s securities regulatory agency.

8.  References. 

You may think that it would be wise to ask the Advisor for references from his or her existing client base.  However, SEC rules prohibit Advisors from using “testimonials” from current or former clients.  In addition, most clients want their financial information kept secret, so the Advisor will likely not be at liberty to share a name and phone number of a current client.  Therefore, don’t be upset if the Advisor refuses to offer client references.

9.  How Much Of The Advisor’s Money Is In The Program? 

Other than regulatory problems, a wrong answer to this question can put an Advisor out of contention faster than anything else.  It is important, in my opinion, that Advisors “eat their own cooking,” meaning that they should have a substantial part of their own net worth in the program they are asking you to invest in.  Ask Advisors who do not manage their own money why you should trust them to manage your money if they don’t trust themselves to manage their own funds?

Conclusions 

As I mentioned at the beginning, the information above is by no means exhaustive.  However, you now have a good introductory road map to guide you through the world of Investment Advisors.  You will find that information gathered under any of the steps above can lead to further investigation and will certainly bring up other questions to be asked. 

There are other steps I left out due to space limitations or because they are usually unfeasible for an individual investor.  One such step is an on-site due diligence visit with the Advisor.  I omitted this step because it is usually cost prohibitive for most individual investors to travel to every potential Advisor’s place of business.

Although the on-site visit is usually impractical for an individual investor, at my firm this is one of the most important steps of all.  It has been my experience that the on-site visit with the Advisor either makes or breaks the deal.  

The on-site visit allows you to actually make sure there is an office.  Anyone can take a picture of a building and stick it in their brochure.  The on-site visit also allows you to meet and interview the principals and administrative personnel and get a feel for their competence.  This is also the best way to verify the track record by looking at copies of client account statements.

Perhaps the most important thing the on-site visit provides is the ability to sit down with the Advisor and get a “feel” for his or her professionalism, personality, sincerity and interest in doing business with you.  I have walked away from more than one Advisor simply because I had a bad feeling about the Advisor’s sincerity or integrity during the on-site visit, even though all the information we had prior to the visit looked great.

While it is probably going to be impractical for you to go visit every “finalist” on your list of prospective Advisors, I would recommend that you try to do an on-site review with the one that is your final selection.  This is especially true if you are investing a large amount of money.

By now, the time and expense commitments related to obtaining a database of Advisors, conducting on-site visits, and evaluating each of them will likely lead many of you to conclude that professional money managers are beyond your reach.  However, this is not necessarily the case.

There are a few firms such as my company, ProFutures Capital Management, that: 1) monitor hundreds of Advisors on a continual basis; 2) do all of the research to find the top performing Advisors; and 3) provide you a short list of recommended Advisors based on your goals and financial situation.  We call this service “ ADVISORLINK®,” because we link investors to Advisors suitable for their investment goals.

Because we represent hundreds of investors all across the country, and over seventy million dollars in assets, we can afford to access the expensive Advisor databases, subscribe to the computerized analytical tools and conduct on-site due diligence visits that are so important to the Advisor selection process. 

In conclusion, I strongly recommend you use professional Advisors to manage at least a portion of your investment portfolio.  In my own case, I have professionals manage nearly ALL of my money, even though I have been in the investment business for over 30 years.   

Yet as you’ve seen by reading this report, finding and selecting the best Advisors is not an easy or inexpensive process.  But don’t let that turn you off.  If you would rather not go it alone in searching for an Advisor, we would be happy to assist you.  For more information on our ADVISORLINK® program, CLICK HERE to go to the ProFutures website.  You can also give us a call at 1-800-348-3601 to talk to one of our experienced Investor Representatives.

[EDITOR’S NOTE:  This is the second installment of my series called “The Mutual Fund Merry Go-Round.”  Part ONE was published on June 20, and is available on my website.  These E-Letters include certain information I have never made public before.  However, because of my desire to see readers improve their investment returns, I am waiving my copyright protection on these issues; you may reprint or otherwise share them with anyone you may choose. ]

Wishing you good luck with all your investments,

Gary D. Halbert

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Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc. Gary D. Halbert is the president and CEO of Halbert Wealth Management, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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