COLUMN-High costs dim appeal of multi-asset funds

Fri Apr 12, 2013 3:07pm EDT

By John Wasik

CHICAGO, April 12 (Reuters) - On paper, multi-asset funds look great. These tactical "fund of funds" let an investor cover objectives ranging from inflation protection and income to international growth, while enabling managers to diversify quickly and avoid market sell-offs.

On the market for years, multi-asset funds have gained traction since the 2008 financial crisis. They have come into focus lately because many retirement plans have added them to their line-ups.

If the funds performed their jobs well at a low cost, then they would make sense to me. Picking a diverse mix of asset classes is challenging, and it would be helpful to average investors to have it done for them.

But the way they are structured now - with multiple layers of fees and high turnover of holdings being bought and sold - only ensures that fund managers will benefit, not you.

THE BIG EXAMPLE

Take the PIMCO Global Multi-Asset A Fund, which is run by a company with more than $2 trillion under management and a great reputation as the world's largest private income-fund manager. As one of the largest funds in this category with $5 billion in assets, it offers an array ranging from emerging markets stocks to bonds (more than half of the portfolio).

But when you look at the expenses, it's hardly a good value. The "A" class of the fund charges a 5.5 percent commission. On top of that, PIMCO will charge nearly 1.6 percent a year for net management expenses, plus a 0.25 percent maximum 12(b)1 marketing fee. Over three years, that alone would cost a projected $1,000 for each $10,000 invested.

Multi-asset funds have yet another layer of expenses that are not immediately apparent, nor does an accounting turn up in the annual expense ratio. Since the fund moves in and out of asset classes, expressed as "turnover," there are transaction costs for buying and selling securities.

The PIMCO fund has a turnover of 94 percent, meaning nearly all of the securities within the portfolio are bought or sold within a year. That expense could cost you an additional 1 percent a year, which is subtracted from your total return.

What do you get for all of this money? Not so much right now. In the past year, the PIMCO fund has returned 5.4 percent, compared to the 19.3 percent for the SPDR S&P 500 Index ETF , a passive basket of large U.S. companies, that only charges 0.09 percent in fees by comparison.

With all the fees wrapped in, that means if you bought $1,000 of the PIMCO multi-asset fund a year ago, and all charges were deducted, it would only be worth about $600 right now, while the same amount in the SPDR fund would be worth about $1,182.

Similarly, high expenses and disappointing returns crippled other major funds in the category.

The $121 million Guggenheim International Multi-Asset Income ETF, which invests in global stocks, has a 0.7 percent expense ratio and a 2.6 percent three-year return.

The BlackRock Multi-Asset Income Investor A fund, sports better performance - nearly 10 percent over three years - but is hamstrung by a 0.98 percent expense ratio and 5.25 percent sales charge.

While this is just a small sample of this category, nearly every fund of funds is going to have the same problem of high expenses, which will clip returns.

ALTERNATIVES

You can either build a portfolio with low-cost exchange-traded funds or consider a plain-vanilla balanced fund such as the Vanguard Balanced Index Fund.

It keeps a constant 60 percent of its holdings in a broad stock-market index and 40 percent in a bond index. The fund's expense ratio is 0.24 percent annually; there are no other charges. It's up almost 10 percent over the past three years.

Also see the "ready to go folio" categories at Folioinvesting.com (), which can match a specific objective you have in mind to a pre-designed portfolio.

As a rule, fund expenses will consistently devour returns over time; they're even more pernicious with actively managed portfolios. The greater the expenses and number of managers involved, the lower the returns. This "cost matters" maxim holds true no matter how many tools managers have at their disposal.