YOUR MONEY : FUNDS AND 401Ks : ‘Wrap’ Plans Offer Convenience, but Be Sure You Know What You’ll Get
Investors’ appetites for mutual funds sold a la carte may be on the wane, but their hunger for funds served up through so-called wrap programs remains unsated.
Mutual fund wraps, typically sold by banks, brokerages and now even some fund companies, are portfolios of funds constructed by financial professionals to suit an investor’s individual needs, goals and tolerance for risk.
The service--which often requires at least a $50,000 upfront investment--comes with personal financial advice, particularly concerning asset allocation. Your fund portfolio is actively managed for you as your needs and circumstances change.
The plans are popular with some investors whose assets are significant and who don’t have the time, skills or desire to create and monitor fund portfolios on their own.
“A mutual fund wrap is a convenience,” says Lou Harvey, president of Dalbar, a Boston-based research firm that tracks the financial services industry.
In addition to specific advice, wrap plans provide investors with a way to aggregate all of their assets in one place. You get a single comprehensive account statement instead of dozens of statements from different fund companies.
For all of that, investors pay an all-inclusive “wrapped” asset-based fee. Hence the name.
The fund wrap business is still in its infancy: Fund assets held in these programs account for just 2.2% of total stock and bond fund assets.
But assets invested through fund wraps are expected to grow as much as 35% a year for the next five years, according to a recent study by Cerulli Associates, a Boston-based financial services consultant. That’s much faster than fund assets overall are expected to grow.
A key source of wrap business: investors who are rolling substantial 401(k) plan assets into individual retirement accounts and are looking for help in directing the assets.
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With at least 68 fund wrap programs competing for investors’ dollars today--and such major players as A.G. Edwards, Merrill Lynch and Fidelity Investments offering them--the level of services and the costs vary widely.
The first question to ask, of course, is whether fund wraps are worth the money.
Because wrap plans invest in mutual funds, you’ll not only have to pay the outer layer of fees charged by the wrap program, but also the annual management fees charged by each fund in your wrap portfolio. Combined, you could be paying more than 3% of assets each year in fees.
That’s one reason Harvey says that “wraps are not God’s gift to humanity.”
Another major issue: Because fund wraps invest exclusively in funds, they can’t offer anywhere near the level of tax management that a “consultant wrap” can.
Consultant wraps, or separate investment accounts, are brokerage arrangements whereby investors pay professionals to manage a basket not of mutual funds, but of individual stocks and bonds. As a result, consultant-wrap money managers can specifically tailor their buy and sell decisions to minimize taxes for their clients. Realized losses, for example, can offset realized gains.
By contrast, mutual funds typically must pay out capital gains annually, and neither the investor nor the fund wrap manager can control such payouts.
(Of course, if the fund wrap is within an individual retirement account, tax considerations are moot.)
If you think a fund wrap program may suit your needs, here are some basic questions to ask before investing through one:
* What are the fees? The typical fund wrap program charges investors 1.25% to 1.5% of assets each year--over and above the management fees levied by the mutual funds within the wrap.
Depending on the type of financial institution you’re buying the wrap through, the fees can be considerably higher or lower. According to the Cerulli study, fees for the average fund wrap sold through an insurance company range from 1.6% to 1.75%. The typical mutual fund company will charge 1.08% to 1.13% for similar services.
Also, ask the wrap program for a printout of management fees charged by the individual funds used in the program. After all, what’s the point of going with a low-fee wrap if it can invest only in high-fee funds?
* Which funds can your wrap own? A wrap can only be as good as the funds that it’s allowed to buy.
Make sure you’d be happy with the choices. Get a complete list of the funds offered through the program, and do a quick check of the ratings that independent fund tracker Morningstar Inc. assigns to each fund. You can do that via Morningstar’s Web site: https://www.morningstar.com.
* Is it a discretionary or non-discretionary program? In some fund wrap programs, you give the company or the financial advisor the discretion to buy and sell fund shares on your behalf. In non-discretionary programs, you don’t cede that authority. Instead, the advisor who manages your wrap will simply recommend that specific changes be made to the portfolio--the final decision to buy, sell or hold will be yours.
Make sure you know exactly who retains that authority before handing over your money.
* Is there a cost for exiting the wrap program? After a few years of investing through a wrap, it may be that you’ll decide you can manage the portfolio of funds on your own.
With that possibility in mind, ask what the procedure is for removing the wrap. In the vast majority of cases, you’ll be able to lift the wrap while maintaining ownership of the underlying funds--without incurring a taxable event. Still, that’s not guaranteed in all plans.
“It’s absolutely important to ask that kind of thing upfront, before you enter into that relationship,” says Jeff Benjamin, co-author of the Cerulli fund wrap study.
* Might a “fund of funds” serve you just as well? Or better? If you want someone to manage a diversified basket of funds for you--and if you want some degree of tax simplification--you might be better off going with a basic, off-the-shelf fund of funds instead of a fund wrap.
A fund of funds, such as those offered by T. Rowe Price, Scudder and Vanguard Group, is a mutual fund that simply invests in other funds, usually from within its own family of funds. It’s designed to be an all-in-one portfolio.
Capital gains generated by the individual funds within the fund of funds are still taxable, but they will be passed on to the investor through the umbrella fund in a lump sum. So instead of receiving annual capital gains statements from a slew of funds, you’ll get just one statement from the fund of funds.
However, a fund of funds typically won’t give you the degree of portfolio customization that you’d get from a fund wrap program.
“With a wrap, you’re getting the actual advice--for instance, on how to allocate your assets” among funds, notes Benjamin. With a fund of funds, you have no input on which funds are in the mix.
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Do you have ideas for mutual fund and 401(k) topics for this column? Times staff writer Paul J. Lim can be reached at paul.lim@latimes.com.
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Rise of Wraps
While overall demand for mutual funds is slowing dramatically, investors’ appetite for mutual fund “wrap” programs continues to grow. The allure: The plans create and monitor personalized fund portfolios for investors. How fund wrap assets have grown:
In billion
‘93: $7.3
‘94: $11.5
‘95: $18.9
‘96: $33.3
‘97: $52.5
‘98: $76.9
‘99 1st-qtr: $82.5
Source: Cerulli Associates
