I wonder, sometimes, if I’m more irked by high fund fees because they degrade my returns or because they reflect an annoying sense of entitlement on the part of managers who think we owe them a lifestyle far more opulent than our own. At base, is my objection practical or moral?

Landon Thomas’s long article in the New York Times looks at Ron Baron’s comp and pushes me hard in the direction of the latter: Mr. Baron seems to have an almost superhuman sense of his own worth (“Why Are Mutual Fund Fees So High? This Billionaire Knows,” 12/30/17). For those who don’t subscribe to the Times, CNBC published a good excerpt of the piece.

Here’s a precis of the article:

1. The Baron funds charge a lot, even after their assets hit the multi-billion dollar range. Mr. Thomas reports that Baron’s fees are about 50% above the industry average.
2. Founder Ron Baron is perfectly happy with that arrangement, “We have made $23.6 billion for our clients,” he says. We’ll note two flaws in this argument: (1) the vast bulk of those returns are simple growth in the stock market, not Mr. Baron’s brilliance and (2) the bulk of the outperformance is ancient history. Mr. Baron cites the record since inception (a 30 year span) for his two oldest funds, while neglecting to mention the fact that Baron Asset has trailed both its peer group and low-cost competitors such as Vanguard Mid Cap Growth (VMGRX) over the past 20 years.
3. Baron is living high, and loves it. He’s worth $2 billion, his family has $670 million invested in the funds, he owns a $150 million home and his annual shareholder meetings are platforms on which to display, and through which to validate, his vast wealth.
4. The system is rigged to keep it that way. Many members of his board of trustees, nominally his investors’ representatives, have been in that role for 30 years, a well compensated (the firm’s 2017 Statement of Additional Information reports compensation of $115,000 – 143,750 for the independent trustees) for a distinctly part-time job and have absolutely no incentive to rock the boat. The board has agreed to a contract that compensates Mr. Baron and other key players based on the firm’s assets under management, which creates an incentive to vacuum up money whenever the opportunity permits. That helps explain the 0.25% 12(b)1 marketing fee he imposes.

Investors have noticed. Assets at Baron Growth (BGRFX) have fallen from $6.9 billion in 2007 to $2.7 billion today and his flagship Baron Asset (BARAX) fund has dropped from $4.3 billion to $2.0 billion.

Mr. Baron, unworried, smiles and maintains both funds’ high fees. With a management fee of 1.0%, those two funds alone generate $47 million a year in revenue for his management company.

The sense of entitlement is regrettably common. Our colleague, Charles Boccadoro, has been visiting fund advisers over the past few months, and he’s coming away repeatedly frustrated by the simple fact that managers charge as much as they can get away with. Investopedia reports the industry-wide averages:

A survey conducted by Russell Reynolds Associates revealed that fund managers at banks make an average of $140,000, while mutual fund managers at insurance companies make $175,000. Fund managers at brokerage firms make $222,000, and mutual fund companies’ mutual fund managers make an average of $436,500. Managers working for larger funds make significantly more …

We’ll note that the $436,500 isn’t the average for excellent managers, entrepreneurial managers or large-fund managers. No, no, it’s what the average schmoo pockets. And there’s a 95% chance that the schmoo in question offers less value than keeping the money yourself and buying an index fund.

There are managers who earn their fees and more. Indeed, some managers simultaneously over-earn their fees and reduce them to offer greater benefit to their investors; Andrew Foster and the folks at Seafarer are a case in point. Many managers of small funds make nothing, regardless of what the prospectus says. By way of example, on behalf of an MFO reader (hi, Judith!) who had questions about prospectus provisions concerning a performance bonus for the manager and other expenses, we reached out to Rondure Global. They confirmed what we told our reader: the manager is underwriting the firm’s existence, rather than vice versa. As a brand new operation, Rondure depends on a line of credit from its partner Grandeur Peak

…and from Laura Gertiz herself to keep the firm afloat for quite some time. Laura may take a very small amount of compensation this year (only enough to allow her to participate in our 401k program), however most of the expenses are coming out of her own pocket at this juncture so it doesn’t make sense for her to be paid any significant amount. That will obviously change in the future, however, you should be aware that if Laura does earn a bonus after profitability is reached, 100% of it will be plowed back into the funds on a long-term vesting schedule in order to align her incentives with those of our investors.

For investors, there are two dangerous questions: (1) how much am I paying? And (2) am I beating the market? They’re dangerous because they encourage you to judge your manager on irrelevant criteria. In place of the first question, we’d suggest asking “am I getting full value for what I’m paying?” Managers can add significant value by moderating risk, offering access to intriguing and otherwise inaccessible asset classes or by giving you the confidence to hold on through tough times. Your worst enemy is you, and your best friend can be a manager who makes you a better investor.

In place of the second question, we’d suggest asking, “is this manager helping me achieve my life goals?” Unless you are a terribly sad and lonely person, you’re really not going to want “he outperformed the Dow by 0.25% annually over his long life” to be the first line in your eulogy. Market-beating means nothing! Losing 19% when the market loses 20% is nothing to cheer. Suffering vertigo and anxiety as your manager charges into, and beats, a foam-filled market is nothing to cheer. Beating the market steadily, whether by 1 basis point or 1000, tells us nothing about whether you’ve been able to lead the life you’ve aspired to. Focus, instead, on what’s meaningful: are you making steady gains of the sort that will allow you to enjoy life, to make a difference in the world, and be rich with friends and family? If so, you’re winning. Celebrate.

BUT if you’re one of the millions of investors whose investments serve mainly to underwrite the lifestyle of an unimaginative member of the herd, act now! MFO Premium offers one very fine suite of tools for assessing whether you’re being treated reasonably (check your manager’s five- and ten-year rolling averages to see whether you might reasonably expect the sorts of returns you need to meet your goals) while ActiveShare.Info offers another.

ActiveShare, underwritten by the folks at Touchstone Investments and guided by the research of Martijn Cremers of Notre Dame, offers another. For domestic equity funds, Active Shares measures the proportion of a fund’s portfolio that simply mimics an index’s; the “different from the index” proportion is called the active share and it’s where the manager can add value. Funds with high active share – 70% or more, depending on the asset class – have the greatest potential to justify their “active” expenses. The site even allows you to calculate what you’re actually paying for the manager’s skill by factoring the size of the active share into an expense ratio calculation: a 1% fee on a fund with 100% active share means all of your money pays for independence from the index, so your active share costs you 1%. Contrarily, a 1% fee on a fund with 10% active shares means the expense ratio on the active part of the account is nearly 10%! Avoid such funds.

Bottom line: for investors in the Baron funds, the same questions apply. Are you so heartened by Mr. Baron’s showmanship and reassuring visage that you’re willing to pay a 50% upcharge for his funds? If so, you’re being charged fairly. If not, check out Nicholas II Fund (NNTWX) which has been around longer, charges less, returns more and has a smaller asset base.