Steven Kiel's  Instablog

We closed out the first quarter for The Hayek Fund on December 6, 2010. To learn more about the returns, some thoughts on the holdings, and our commentary on the economy, please visit: The Hayek Fund: Quarterly Results and Commentary. 

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When I first launched my investment management firm last year I struggled administratively to find the best way to manage my clients accounts. For the first six months or so, I managed them as typical separately managed accounts. Within the first two months, I realized that was going to be a problem. It was time consuming to make a small adjustment to the portfolio across all of my client accounts and there were allocation issues. I'm a portfolio manager, not a financial planner, and the custodian I was using wasn't set up to operate that way. I knew I needed to make a change. Early in 2010 I stumbled across Cale Smith from Islamorada Investment Management down in the Florida Keys. He had created the concept of a "spoke fund," which was exactly what I was looking for to streamline the administrative tasks and make the the portfolio as investor-friendly as possible. It's not an exaggeration to say that Cale's idea was a Godsend for me.

The picture here to the left is a picture of a mutual fund setup. All the money is pooled. Investors own a share of the mutual fund, not the actual stocks in the mutual fund. Same way for a hedge fund. Surprisingly, less than half of all mutual fund portfolio managers even invest in the funds they manage. It's difficult for me to even express how disgraceful that is. More importantly, though, it's an indicator that they aren't confident in their own fund. Needless to say, I would never invest in that.

This beautiful blue picture, on the other hand, is the spoke fund model. It's not pooled. Investors have their own accounts and actually own the shares of the companies in the model. So, think of it this way, if we own 20 companies, and one of those companies is, say, Coca-Cola, then you would actually own the shares of Coca-Cola. If a mutual fund you were invested in were to own Coca-Cola, you wouldn't actually own the shares. You'd just own an interest in the shares. This is a big deal and a big difference. By owning the actual shares you have the ability to control your taxes. Our custodian provides the option to match up tax lots in order to reduce the appearance of your short-term capital gains, and maximize the appearance of your lower rate long term capital gains. We estimate that being able to do this will save you 4% annually.

Okay, so that's the pooled v. separate account information. Let's move on to transparency. If you've invested in a mutual fund before, you know that you basically get a statement every quarter that lists the holdings. Yeah, you can see what the daily fund price is, but what if you have a question about the fund or its holdings? You have no one to call (Other than maybe your broker, which would be a mistake in most instances. Remember, they're not a fiduciary.). In the spoke fund model, you can login to your account 24/7 to see the holdings and allocations, to view and print out monthly and annual statements, and to make administrative changes. Most importantly, though, you can call up the portfolio manager to chat. Imagine calling a mutual fund manager's office and asking to speak to him! You'd be laughed right off the phone.

Spoke funds also have focused portfolios. Our two portfolios, The Freedom Fund and The Hayek Fund hold less than 30 positions. The idea is that these positions are deeply researched and known very well. Why would you want to invest in a portfolio manager's 89th best idea? That never made sense to me. A typical mutual fund holds about 140 positions. That's not diversification, that's taking market risk, which is the biggest risk of all. It's better to have a focused portfolio of stocks that we feel are undervalued. That's the better way to reduce risk.

Okay, now to expenses. Spoke fund expenses and fees are clear, transparent, and fair. Mutual fund expenses and fees are hidden, not transparent, and in most cases, not fair at all. I already talked about how badly designed mutual funds are for tax purposes and how you typically lose 4% a year on that issue without even knowing it. How about the loads and 12b-1 fees mutual funds charge? They use these to pay their salesman (read brokers). We don't have those fees. I'm the salesman. To open an account, all you have to do is call me (571-766-8089, by the way). We make our money by making you money, not by taking a sales fee for signing you up to our own fund. Mutual funds also pass on their trading commissions. In the vast majority of cases, we don't.  In fact, we haven't yet incurred a trading fee through our custodian, FOLIOfn. I don't want to say we never will but it will be very rare. Spoke funds put your money to work. They don't use your money to pay others.

So, why are spoke funds better?

1. Trust- I'm a Registered Investment Advisor and have a fiduciary duty to put your interested first. I have nearly all of my net worth in the two spoke funds I manage
2. Transparency- With a spoke fund, you have online access 24/7 to view the fund’s holdings and statements, and an open phone line to the fund manager. 
3. Low and clear expenses- Spoke funds have a tax-friendly structure, low turnover, and no hidden fees
4. A focused portfolio- Spoke funds put your money in the portfolio manager's best ideas, not their, um, 112th best idea

Right now there are three portfolio managers and five portfolios that go by the spoke fund name and requirements. I have a feeling there will be new ones sprouting up all the time. Good ideas succeed, and this is a good idea. I've already mentioned Cale Smith. You also may want to check out Kevin O'Reilly at Foothills Planning. We also have a new website and blog about spoke funds that I'd encourage you to check out. Just click on spokefunds.com. From there you can find the LinkedIn page, Twitter account and all those other social media pages. If you have questions, just shoot me a line.

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