April 17, 2005

Management structure and asset location
Structure may affect where you hold funds

The recently announced departure of AIC's outspoken fund manager, Larry Sarbit, is the latest in a series of high profile manager moves. Thinking about this recently, it occurred to me that one could make a case for making asset location decisions (i.e. whether to hold a fund in a tax deferred or taxable account) based on the structure of portfolio management responsibilities.

Management team structure

Investment fund managers generally fall into two very broad structures. First is the traditional team-oriented management team - i.e. Franklin Templeton, Brandes, Standard Life, Mawer, etc. - whereby an individual may or may not have full decision-making power. But the structure of the investment process is very team-dependent.

The second type of structure is where the investment process and final decision-making power on the portfolio are placed largely (if not entirely) on the shoulders of an individual lead manager. This is common in one-man shops and other smaller boutiques.

Further, in both instances, there is the consideration of whether a fund is managed in-house, or through a sub-adviser agreement. We need only look to the impact of Brandes' decision to terminate its agreement with AGF to start its own family of funds in Canada to remind us of the risk of sub-advisers.

In my view, Larry Sarbit operated in a fashion that most resembled the second type of structure. It is my impression that Sarbit was left to 'do his thing'. He usually worked closely with one other analyst but Sarbit made his own decisions. And while he participated in portfolio manager meetings at AIC, Sarbit always went his own way when making portfolio decisions.

Tax implications of manager changes

There are two sources of tax implications when a fund changes managers, either voluntarily or otherwise. The more obvious consequence involves a new manager coming in and selling many of the inherited stocks to quickly transition the fund to conform to his perception of which stocks represent good opportunities. Where many stocks are sold - at a profit - significant capital gains can result.

The other, indirect source of tax consequences is where investors and advisors are dissatisfied with the change in managers to the extent they feel compelled to sell. Any paper gain is instantly realized on the sale of fund units.

Asset location implications

The implication on where to hold funds, then, may be influenced by the structure of the management teams. For instance, one could argue that funds managed on a very individual basis may be best held inside of tax-deferred accounts like RRSPs and RRIFs. The same could be said of funds that are sub-advised by an external manager.

However, funds managed in-house by true team-oriented management firms are, perhaps, more suitable for taxable accounts. This is because any change in lead manager is unlikely to result in big turnover at the fund level. It's also unlikely to result in any real style changes, giving investors and advisors little reason, generally, to change their tune on such a fund.

These are generalizations, of course, and are always subject to closer inspection on a case by case basis. But don't get carried away with this one factor to influence asset location. While a valid factor, it is but one of many issues to consider in the portfolio construction process.