The volume of financial data can be dizzying to even the most veteran directors. Faced each year with the daunting task of reviewing and analyzing the board book and numerous other accompanying documents, many directors are now turning to outside assistance for "value-added" expertise as they make their way through the contract renewal process. The contract renewal books typically provided are just too big and heavy for the directors’ deliberations. The perspective and "value-added" expertise offered by an outside consultant offers numerous benefits to both directors and shareholders. 

The typical process in "value-added" contract renewal can vary based on the particular characteristics of the complex and the source of the data, but in general it involves the following topics discussed below.

Data Gathering and Analysis

Under the supervision of the "value-added" consultant, the process of creating the data gets underway immediately.  Peer groups, usually 8 to 16 similar funds selected based on assets under management, investment objective, and distribution approach, are pulled for each fund.  The data is sourced in one of three ways: 1) by the management company under the consultant’s supervision; 2) by an outside provider under the consultant’s guidance or 3) directly by the consultant using one of the commercially available mutual fund database providers.   

The comparisons are run and each fund’s percentile rank is determined for each metric.  Working with the board the "value-added" consultant determines the decision criteria for the data; that is, at what level a certain metric passes a threshold and becomes an exception or outlier.

Drafting the "Value-Added" Memorandum

At this point the consultant drafts a memorandum that summarizes the data and, more importantly, identifies the outliers based on the decision criteria mentioned earlier.  The memo is broken up into several sections covering key issues for contract renewal, typically:
 

• Investment Performance: For contract renewal we have typically found that reviewing 3 or 5 year performance is appropriate because it is long enough to capture most parts of the business cycle, yet not so short that it reflects short term swings in the market. We also believe the directors should see a fee comparison with other investment products offered by the advisor and with the low-cost provider in the industry, typically Vanguard or Fidelity Spartan.
• Portfolio Operations: We have found that fund directors benefit from understanding performance in the context of (a) style drift, (b) tax effectiveness, (c) best execution and brokerage and (d) implicit risk in the manner the portfolio is managed. The "value-added" consultant can summarize this information for the board.
• Expenses and Fees: MPI has found that total expenses form the most important metric because they represent the aggregate erosion of performance.  The largest line items expenses are usually management fees, transfer agency, distribution (including shareholder servicing), administration, fund accounting and custody. Expenses which are paid to affiliates of the advisor receive particular attention from the "value-added" consultant.
• Breakpoints in the Advisory Fee: We have found that the directors benefit from seeing a comparison of the structure of the management fee (which may include both advisory and administrative fees). Some funds have a high starting fee followed by a rapid scale down, while others maintain a lower fee throughout the structure. Typically we like to compare effective management fees at a common asset level for all the funds in the peer group.
• Sales Charges: We have come to believe that the directors are well served by a comparison of sales charges from funds which compete directly.
• Shareholder Service Levels: While the "value-added" consultant does not typically create any new service level metrics, we believe it is useful to have a summary of results incorporated in the contract renewal memorandum.
• Profitability: MPI has found that the best metric for assessing fund-by-fund profitability is before marketing and before taxes. Historically fund directors have asked for more detail when the profitability exceeds 77% (the maximum rate set in the Gartenberg decision). However under the new Harris decision MPI believes that fund directors may have even more discretion.
• Waivers and Expense Caps: A "value-added" consultant is able to help the directors assess and compare the net, after waiver, expenses.

A number of evolving drafts of the "value-added" contract renewal memorandum are submitted to the board over a period of several months to ensure accuracy and confirm that all issues are being covered as intended.  Once finalized it is officially entered into the record on the date of the contract renewal meeting. A benefit of the evolving nature of the draft is to allow directors to ask and receive additional information from the management company.

The "value-added" process can save countless hours for the directors, allowing them to focus on what is really important.  The memorandum can effectively summarize 500 or more pages of material into a 10-20 page document.