Mutual Funds to Avoid: The Wrap Account

I am not as negative about mutual funds as some of my fellow bloggers- like everything in life, context is everything and I believe mutual funds have their time and place for certain individuals.

However, if someone is trying to sell you a mutual fund of funds, also known as a "wrap" account, run for the hills immediately-context be dammed!

A wrap account is basically a mutual fund that holds other mutual funds. The primary advantage is that they are suppose to be a one-stop investing solution because you are invested in a little bit of everything.

Here's why I avoid these funds:

1. On principle alone, I find that giving someone fees to pick other mutual funds is basically rewarding a lazy person. These fund managers are saying to me that they are too incompetent to pick their own investments so they'll get other people to do their job. I might as well buy exchange traded funds indexed to the stocks and bonds and reward my own laziness.
   
   
2. Fees: in a previous life, I did some work in the hedge fund industry. Some hedge funds are also packaged as a fund investing in other hedge funds- we use to nickname these structures "fees on fees" in private and the same applies here. A WRAP account's performance is reduced twice by management fees: once at the fund level that the wrap account has bought and another at the wrap level- you have two middle-persons skimming off the performance of the fees.
   
   
3. I'll let this quote from the March 16, 2007 edition of the Globe and Mail Report on Business speak for itself (page B10 for credit purposes) : "Some fund companies are using wraps as a means to sweeten compensation of financial advisers and, ultimately, to build business...recent offerings...pay above-average 'trailers', an annual fee based on the client's assets invested." (emphasis is my own)
   
   
4. I learned this the hard way (sins of my youth one supposes)- some wrap accounts lock you in for 5 years or more so you can't get out without paying a penalty (explaining why the trailers are higher).

One way of benefiting from a WRAP account would be to find out who the leading sellers of Wrap Accounts are (in Canada, by assets under managment, it is CIBC, TD and IGM according to the Investment Funds Institute of Canada) and buy their stocks and not their WRAP Funds. As the above indicates, WRAP Accounts are cash-cows for financial institutions- might as well make money buying common shares of these institutions.