Mercy! Mercy! That Dang Nabed PERCY!

Two Bags Full

Two Bags Full

A mutual fund has two major account categories they keep book on. These are investor money and fund money. Now it is a reasonable to ask, “Where does the fund money come from?” At the fund’s inception some is no doubt “Seed Money.” This is money to get the fund up and going. No doubt that for the life of the fund the profits the fund generates pays interest on the seed as a part of operating expenses. Over the long term however, most of the “Fund” money comes from profits. All profits are not paid annually to the investors as one may believe. A percentage is moved from the customer money account to the fund money part of the leger.

For Example suppose a fund incurred losses of $6 Million in a fund cycle and revenues of $14 Million. That means the profits for the year were $8 million. The first thing the managers will ask is what will the traffic bear with the investors? By this they mean is how measly a percentage of the take can they give their investors before the members get disgusted and decide to move their money elsewhere? Now let’s say management decides that the payout on shares is going to be around 8 Percent. Anything less will make them look like just another “Ho-Hum, Luke warm, uninspired fund”. So they do some sensitivity analysis with different arbitrary percentages around the 8% threshold. If we pay 8% their reasoning might go, the investors will swallow it… but how much will that leave us to transfer into the General Fund? .

After playing with the numbers the Brain Trust decides that 7.1% is the best that they can pay out to the “I” investors and 7.9% to the "Y” investors. Say the result of this decision pays out $6M and leaves $2M to be transferred to the General Account (GA). The GA is a super slush fund the managers can do anything they want with. (Naturally with the approval of the board which consists of clueless members often appointed by management and rubber stamped at the annual shareholders meeting.) The General Account pays the bonuses we hear so much about but sometimes it must be used to cover-up some of the serious managerial gaffs. Keep in mind Management fears the investors will walk, if payoff expectations on shares fall short of what intuition tells them the market should have yielded. However, this is conjecture because the investors are never privy to the real number crunching. They must rely instead on rules of thumb based upon market experience.

So what the CEO does at the annual meeting is lament what a “Challenging” year it was and try and sell the numbers cooked up by the CFO to the stockholders. Great stress is placed on all the risk and volitility and how profits were wisely garnered from a stubbor and unyielding market place while how good earnings actually turned out to be is downplayed and covered up in a kubooki dance of statistical voodoo. Tomorrow I will talk about Dividends.