Well-diversified, risk-controlled portfolios

The title of this blog came straight out of a letter I received today from my retirement fund. They have hired a new firm of investment advisors. The terms of that agreement are defined in the letter.

It gives us a chance to see what we can do with math, as grownups concerned about retirement funds, over-paid bankers, volatile stock markets, etc.

This particular advisory firm is joining 5 other advisor firms, replacing one that is dropping off. The five who are staying on will receive the same fees as they did before. These advisors receive fees equal to 0.14% of the fund's average annual net assets, paid in installments at the end of each quarter.

QUESTION: If the value of the fund at the end of December 2009 was $34.9 billion, what were the approximate fees for the year?

We don't know the amount of the fund balance for each quarter, so we'll just use the annual balance for our calculations. Even though this is not entirely accurate, it's close enough for us.

$34,900,000,000
                   x .0014
       $48,860,000

ANSWER: Just a bit less than $50 million, plus adjustments.

That charge is adjusted up or down by a factor based on the performance of the fund over a 60-month (5-year) period compared to the performance of the Russell 3000 Index over the same time period. The fees paid to the group of 6 advisors were reduced by $2.7 million (.01%) at the end of 2009 because they failed to meet their targets.

$48,860,000
  - 2,736,000
$46,124,000

That means they got $46 million, split roughly 6 ways.

That drops the average fee (per advisor company, not each person) down to $7,687,333.

The new advisor is expected to manage 8.5% of the total portfolio; about 35-45 stocks,  There's an expected turnover of about 40% in those stocks, meaning four out of ten will be sold and replaced with something else.

QUESTION: How many stocks are expected to be sold this year by the new advisor?

35 x .4 = 14
45 x .4 = 18

ANSWER: 14-18 stocks will be sold and replaced with new stocks.

QUESTION: How much will the new advisor firm be paid for the 8.5% percentage of the fund being managed, assuming they meet the performance target?

$34,900,000,000

                        x .085

     $2966500000    or $3 billion being managed.

                        x .0014

         $4,153,100

ANSWER: The new advisor firm can earn about $4 million dollars.

Isn't math fun, and lucrative? Well that's another question.

How much did this fund earn last year? It increased 27.17%
But the fund advisors were also rated based on their performance over 5 years, which was 0.9%

Ah well. Not always so good for them ... or us!