By Tom Bradley

The Globe and Mail, Report on Business
Published September 15, 2007

If you've been a regular reader of this column, you know that I sometimes write about things that are driving my wife crazy. When Lori gets on a rant about something and wants me to write about it, there's only one way to make it go away. Write about it.

Her current rant is aimed at this very section of The Globe and Mail. Every Saturday in the statistics section of Report on Business, the performance of the 180 largest mutual funds is prominently reported. Given her considerable investment of time and money in starting a new mutual fund company, she is frustrated to see the business media's rote support of the industry's big boys. "It's hard enough to start up a new fund firm, without the media reinforcing the status quo." Words like "oligopoly" and "hegemony" punctuate her diatribes.

Of course, Lori's rants and this column are more than a little self-serving, but that doesn't negate the point. There are lots of people that feel the mutual fund industry has not served investors well. Fees are generally too high, funds are too index oriented, managers are changing horses constantly and fund firms focus on what's easiest to sell (past performance) rather than what clients need. On the flip side, there is plenty of evidence, including studies by academics and independent consultants, indicating that in general, small funds perform better than large funds.

In light of this fact, investors would be well served to know more about funds offered by firms like ABC Funds, Chou Associates Management, GBC Asset Management, Leith Wheeler Investment Counsel, Mawer Investment Management and my firm, Steadyhand Investment Funds. It's fair to say that few if any of these firms will show up in the top 180 any time soon, while the banks and megafund companies will always have multiple listings.

There are some compelling reasons for investors to look at smaller asset managers.

First and foremost, small managers have the freedom to go anywhere in their pursuit of value. Because they're small, they don't have liquidity constraints that the big funds have. If they want, they can make a small or medium-sized company a significant holding in the fund. An example of this is the Leith Wheeler Canadian Equity Fund, which has a 4-per-cent position in Toromont Industries Ltd., a Canadian industrial company. If a manager of a huge fund liked the Toromont story and wanted to put the stock in its funds, it would have to be a much smaller position (i.e. 1 per cent or less). As a result, the impact of Toromont on the megafund's performance would be minimal.

In most cases, when you buy a fund managed by a smaller firm, your money is being managed by the founder or founders. The firm's most talented money makers are focused on investing and are the ones making the buy, hold and sell decisions. If you buy a Chou fund, for example, you can be assured that Francis Chou is pulling the trigger. Now, I admit to having a bias here. I firmly believe it is people that make money for investors, not global research teams, risk management systems and/or a rigid decision-making processes.

Related to the founder's involvement, the investor can also be assured that there is a close alignment between their interests and the interests of the fund manager. Invariably in small firms, the managers have a vast majority of their net worth invested in the fund.

This close alignment makes smaller-sized mutual funds very appropriate for individual investors. With a large stake in the fund, the managers don't want to lose money any more than other unitholders do, so they are less likely to be complacent about risk or add a security to the fund that they don't want to own themselves. In the end, that translates into better performance in down markets and higher long-term returns.

It's also important to note that the fees charged by the small fund firms tend to be considerably lower than the megafunds, although this is not always the case.

In singing the praises of the smaller asset managers, I am not suggesting that large firms can't have some of these traits and aren't able to provide excellent returns. It can be done and some have the record to prove it. But William Bernstein, the financial theorist and author of The Intelligent Asset Allocator, captured the challenges facing large investment firms when he offered this rather blunt assessment in a recent publication: "Money managers at large investment companies, banks and insurance companies, [who are] too focused on next quarter's bottom line and next year's bonus, gradually disengage from the slow methodical development of their skills. Add a soupcon of fear of failing unconventionally, stir in a large dollop of groupthink, cook slowly for several years, and competence eventually simmers off."

I don't expect that my editors are going to start featuring the 180 smallest mutual funds in the Saturday Report on Business, but if nothing else, this column has accomplished one thing - it's cooled Lori off for a while.