FINRA has its suitability and fair dealing rules. The SEC recently adopted its new Reg BI rule. Now, the Department of Labor has announced that it is going to enact a new fiduciary rule. Is it any wonder that investment fiduciaries, 401(k) plan sponsors and financial advisors are thoroughly confused as to what rule applies and when? One constant in each rule is a focus on the comparative cost, or cost-efficiency, of investments recommended by an advisor and/or utilized by an investment fiduciary. The Active Management Value Ratio™ 3.0 (AMVR) is a simple, yet powerful, metric that allows investors, investment fiduciaries and attorneys to evaluate the cost-efficiency of actively managed mutual funds and avoid unnecessary losses due to cost-inefficient.mutual funds.

1. InvestSense
2019 AMVR™ 3.0 MANUAL

2. InvestSense
Restatement (Third) Trusts
Section 90 of the Restatement, commonly known as
the “Prudent Investor Rule,” provides that
1. A fiduciary has a duty to be cost-conscious. (cmt. a)
2. A fiduciary has a duty to select mutual funds that
offer the highest return for a given level of cost and
risk or, conversely, funds that offer the lowest level of
costs and risk for a given level of return. (cmt. f)
3. Actively managed mutual funds that are not cost-
efficient are imprudent. (cmt. h(2))

3. Fees
Total
Fees AER
Annual
Return
Active Fund
Expense Ratio 0.65 5.68 16.14% Nominal
14.92% Risk Adjusted
Benchmark
Expense Ratio 0.05 0.05 15.34% Nominal
14.06% Risk Adjusted
IC/IR 0.59 5.63 0.86
% Fees/% Return 90% 99% 6%
AMVR Analysis
InvestSense

4. InvestSense
“The incremental fees for an actively managed
mutual fund relative to its incremental return
should always be compared to the fees of a
comparable index fund relative to its returns.
When you do this, you’ll quickly see that the
incremental fees for active management are really,
really high – on average, over 100% of incremental
returns.”
Charles D. Ellis

5. Fees
Total
Fees AER
Annual
Return
Active Fund
Expense Ratio 0.65 5.68 16.14% Nominal
TO/Trading Cost 29% 0.35 0.35 14.92% Risk Adjusted
Total Active Costs 1.00 6.03
Benchmark
Expense Ratio 0.05 0.05 15.34% Nominal
TO/Trading Cost 8% 0.10 0.10 14.06% Risk Adjusted
Total Bmark Costs 0.15 0.15
IC/IR 0.85 5.88 0.86
% Fees/% Return 85% 97% 5.8%
AMVR Analysis
InvestSense

6. InvestSense
Step 1 – Incremental Return
Active Nominal/Stated Return 16.14%
Active Risk-Adjusted Return (RAR) 14.92%
RAR = 16.14% - [(STDEV sqrd) * .0111)
RAR = 16.14% - [10.45 sqrd * .0111] = 14.92%
IR = Active RAR – Benchmark RAR = 0.86

7. InvestSense
“Past performance is not helpful in predicting
future returns. The two variables that do the best
job in predicting future performance of [mutual
funds] are expense ratios and turnover.”
Burton G. Malkiel
“Do not allow the tyranny of compounding costs to
overwhelm the magic of compounding returns.”
John C. Bogle

8. Fees
Total
Fees AER
Annual
Return
Active Fund
Expense Ratio 0.65 5.68 16.14% Nominal
TO/Trading Cost 29% 0.35 0.35 14.92% Risk Adjusted
Total Active Costs 1.00 6.03
Benchmark
Expense Ratio 0.05 0.05 15.34% Nominal
TO/Trading Cost 8% 0.10 0.10 14.06% Risk Adjusted
Total Bmark Costs 0.15 0.15
IC/IR 0.85 5.88 0.86
% Fees/% Return 85% 97% 5.8%
AMVR Analysis
InvestSense

9. InvestSense
Step 2 – Incremental Costs
Active Expense Ratio 0.65
Active Turnover/Trading Costs 0.35
Active Total Costs 1.00
Trading Costs = [(Turnover * 2) * 0.60
(Bogle’s Metric)
IC = Active Costs – Benchmark Costs = 0.85

10. Fees
Total
Fees AER
Annual
Return
Active Fund
Expense Ratio 0.65 5.68 16.14% Nominal
TO/Trading Cost 29% 0.35 0.35 14.92% Risk Adjusted
Total Active Costs 1.00 6.03
Benchmark
Expense Ratio 0.05 0.05 15.34% Nominal
TO/Trading Cost 8% 0.10 0.10 14.06% Risk Adjusted
Total Bmark Costs 0.15 0.15
IC/IR 0.85 5.88 0.86
% Fees/% Return 85% 97% 5.8%
AMVR Analysis
InvestSense

11. InvestSense
“Closet Indexing” and the AER
The Active Expense Ratio (AER) is a metric
developed by Ross M. Miller. The AER allows
investors and fiduciaries to determine the true cost
of active management.
“Mutual funds appear to provide investment
services for relatively low fees because they bundle
passive and active funds management together in a
way that understates the true cost of active
management.”

12. InvestSense
“Closet Indexing” and the AER
“In particular, funds engaging in ‘closet’ or
‘shadow’ indexing charge their investors for active
management while providing them with little more
than an indexed investment.”
“Even the average mutual fund, which ostensibly
provides only active management, will have over
90% of the variance in its returns explained by its
benchmark index.”
Ross M. Miller

13. InvestSense
Step 4 – Calculating AER
AER Active Weight
AW = SQRT[1-(R-sqrd)] divided by
[SQRT[1-(R-sqrd)] + SQRT (R-sqrd)]
R-sqrd = 97
AW = SQRT(3)/[SQRT(3) + SQRT(97)]
AW = 1.73/11.57 = .1495

14. InvestSense
Step 5 – Calculating AER
AER = IC/AW =.85/.1495 = 5.68 5.68
Active Turnover/Trading Costs 0.35
Active Total Costs 6.03
Trading Costs = [(Turnover * 2) * 0.60

15. InvestSense
Step 6 – AER Adjusted Costs
Active AER Expense Ratio 5.68
Active Turnover/Trading Costs 0.35
Active Total Costs 6.03
AER IC = AER Active Costs – Benchmark Costs
AER Adjusted IC = 6.03 – 0.15 = 5.88

16. InvestSense
Step 7 – AER Adjusted AMVR
AER Adj AMVR = AER Adj IC/Risk Adjusted IR
AER Adj AMVR = 5.88/.86 = 6.83

17. InvestSense
Step 8 – AMVR
Risk-Adjusted Return AMVR
0.85/0.86 0.99%
AER Cost Adjusted IC/Risk-Adjusted Return
AMVR
5.88/0.86 6.83%
Optimum AMVR is a number greater than zero
(indicating positive incremental return) and equal to,
or less than, “1” (showing incremental returns greater
than incremental costs, i.e., cost-efficient).

18. InvestSense
AMVR FAQ
Is the AMVR intended to be used to predict a
mutual fund’s future performance?
No. Investment fiduciaries are held to very high
fiduciary duties, including the duties of loyalty and
prudence. The purpose of the AMVR is to analyze
the cost-efficiency of an actively managed mutual
fund. Funds that are not cost-efficient waste
investors’ money. “Wasting beneficiaries’ money is
imprudent.”

19. InvestSense
AMVR FAQ
Is cost-efficiency that important? Doesn’t the law require
stockbrokers and other financial advisers to always put
customers’ financial interests first?
“Increasing numbers of clients will realize that in toe-to-toe
competition versus near–equal competitors, most active
managers will not and cannot recover the costs and fees
they charge.”
Charles D. Ellis
“[T]here is strong evidence that the vast majority of active
managers are unable to produce excess returns that cover
their costs.”
Philip Meyer-Braun

20. InvestSense
AMVR FAQ
Does the AMVR provide any other information
about cost-efficiency?
Yes. Look at the % fee/% return line on the AMVR
chart. 85%/5.8% indicates that 85% of the actively
managed fund’s costs are only producing 5.8% of
the fund’s risk-adjusted return.
Another analogy would be to “monetize” the funds’
annual costs. Which would you prefer to pay-$15
for 14.06% return or $100 for 14.92% return?

21. InvestSense
AMVR FAQ
Is the AMVR the same thing as the Sharpe ratio?
No. The AMVR compares a mutual fund’s costs to
the fund’s returns.
The Sharpe ratio compares a mutual fund’s risk to
the fund’s returns.

22. InvestSense
AMVR FAQ
Why are a fund’s trading expenses included in the
calculation of AMVR? Aren’t a mutual fund’s
trading expenses part of a mutual fund’s expense
ratio?
No. Trading expenses are part of a mutual fund’s
operating expenses, which are not included as part
of a mutual fund’s expense ratio. Trading expenses
reduce a mutual fund’s return and are often higher
than a fund’s expense ratio.

23. InvestSense
AMVR FAQ
The importance of trading expenses cannot be emphasized
enough. Often referred to a part of a mutual fund’s
“hidden” expenses, studies have consistently recognized the
importance of trading expenses on mutual funds’ returns.
As stated in the earlier Burton Malkiel quote, his studies
have concluded that a fund’s expense ratio and its trading
costs are the two most reliable indicators in predicting a
mutual fund’s future performance.
Or as the late Vanguard legend, John Bogle, was fond of
saying – “Costs matter.”

24. InvestSense
AMVR FAQ
What is AER and why is it included in calculating a fund’s
AMVR?
A fund’s Active Expense Rating, or AER number, helps
investors detect and avoid co-called “closet index funds.
“Closet index” funds are actively managed funds whose
returns are essentially the same as a comparable index
fund, but charge much higher fees than the index fund.
A fund’s AER number is based on a fund’s R-squared
number. Morningstar states that R-squared reflects the
percentage of a fund’s movements that are explained by
movements in its benchmark index, [as opposed to any
contribution by active management.]

25. InvestSense
AMVR FAQ
What is AER and why is it included in calculating a fund’s AMVR?
An R-squared rating of 98 would indicate that 98 percent of
an actively managed mutual fund’s returns could be
attributed to an index fund rather than the active fund’s
management team. If an investor is paying an annual
expense fee 0f 1% for an actively managed mutual fund that
only contributes 2 percent of the fund’s total return, and a
comparable index fund is producing 98% of the fund’s but
charging an annual expense fee of just 0.20% percent, the
effective annual expense ratio for the actively managed
fund is obviously significantly higher than the stated 1%.

26. InvestSense
AMVR FAQ
For more information on the Active Management
Value Ratio™ 3.0, including instructions on how to
calculate the metric, visit the following blogs:
“The Prudent Investment Fiduciary Rules”
http://iainsight.wordpress.com
“CommonSense InvestSense:
The Power of the Informed Investor”
http://www.investsense.com