In an op-ed piece in The New York Times (available here; if you are unable to read the article run a Google search for the term ‘The Mutual Fund Merry-Go-Round’ and click through), David Swensen, author of Unconventional Success: A Fundamental Approach to Personal Investment, rips into the mutual fund industry for putting its profits ahead of producing returns for investors. He charges the industry with abetting investors in chasing performance through marketing campaigns that prominently play up the mutual funds in the line-up that have managed to garner coveted four- and five-star ratings from Morningstar.

Unfortunately for investors, many of the newly-minted four- and five- star funds are successful in attracting a flood of new money but go on to post poor future returns. The fund company isn’t suffering though. Some of the old dogs are now star mutual funds that can now be advertised with their recent performance prominently displayed and the process starts all over again.

Mr. Swensen offers a couple of suggestions for getting off the mutual fund merry-go-round. (1) Investors should learn to avoid the siren song of mutual fund advertisements and invest in a well-diversified portfolio of index funds such as those from Vanguard and (2) Aggressive policing of the mutual fund industry by regulators. Investors may be better off voting with their wallets now instead of waiting for regulators to do the job for them.

This article has 12 comments

  1. A longstanding rule has been to invest in the fund companies themselves rather than the funds. As someone who has worked in fund industry back in the day, it really is all about market share, commissions, and trailer fees. The industry preaches long term investing but practices churning. With all the turmoil, we are seeing more people taking control of their investments. Slowly and surely.

  2. Kind of sloppy journalism here. The recommended “well-diversified portfolio of index funds“ are actually mutual funds as well. The headline and primary text should describe the villains as actively-managed mutual funds, and also comment on their MERs.

  3. I’m a stock picker and I’ve owned a lot of stocks in my day, but none have performed as well as the first stock I ever bought, which was BPI Funds ( BPF). They were acquired by CI Funds (CIX) and ultimately paid me back 10x my original investment by the time I sold my shares of CIX.

    I think that fact alone speaks volumes as to how much money the fund companies in general earn in fees. Ironically, before that, I was purely a mutual fund investor through my Group RSP at work. When I eventually had some money to do my own investing outside of my RSP, I figured that if I don’t like the ridiculous fees that this so-called “financial industry” charged, then maybe I should buy their shares. Boy was I ever right on, there!

  4. It’s looking like ETF’s are heading the same direction as many “products” that are getting dumped on investors are really actively managed index funds (oxymoron). I did a quick scan on the next-gen ETF vendors that are publicly traded and here’s what’s out there:

    Blackrock (BLK) – iShares products
    Jovian Capital just sold the Horizon Betapro to a Korean outfit
    Invesco (IVZ) – PowerShares ETF’s

    These may be worth doing some further research.

    @sageinvestors

  5. @David: More than the fees themselves, this Swensen article is a criticism of the mutual fund industry’s habit of encouraging performance chasing. Nevertheless, I think you have a fair point.

    @Phil S: Agree. In the past mutual funds had twin engines of growth. Investors were adding money regularly and the markets were growing as well. IMO, despite the growth in alternatives such as ETFs and low-cost funds, high-MER funds remain very popular. Not to mention the chartered banks also have significant asset management operations these days.

    @Sage Investors: Yes, ETFs are heading down the same path as mutual funds encouraging investors to chase performance. Witness the growth of leveraged ETFs as well as niche sector ETFs.

  6. Article is far o general in its criticism. with no specifics offered in the area of returns or fees or anything else….

  7. @CC. You forgot to mention the Life Insurance companies!

    They take your life insurance premiums and build up these massive investment portfolios in the hopes that their investment portfolio grows faster than your death benefit in guaranteed benefits, or else they just fee your policy to death in the cases where your benefit amount isn’t guaranteed… Or, in the case of term life insurance policies, that the policyholder outlives the life of the term policy altogether so that your premiums become 100% profit for the lifeco.

  8. His message isn’t a new one, but he sure doesn’t hold back. :)

    Buffet is another active manager who recommends passive investing. The problem is that most of the people who read Swensen’s article are probably already passive investors.

  9. @rudolph: David Swensen has offered practical tips for investors in other places. Here’s one:

    http://www.canadiancapitalist.com/how-to-pick-a-winning-mutual-fund/

    @Phil S: And many life insurance companies own asset management companies themselves, so they have their fingers in many pies. Just like our banks!

    @Mike: David Swensen is a very harsh critic of mutual funds even though US funds are much cheaper than what we have here. I wonder what he’ll have to say about Canadian mutual funds.

  10. Given that Target has shaken up the retail space in Canada this year, what are your thoughts in investing in commercial real estate (obviously, we have our own strong opinions, but would like to hear your thoughts)?

  11. Swensen would go wild if he knew what Canadians are willing to pay for active mutual fund management. He probably already knows and think we’re nuts, at least those that own them.

    I will check out the link above “how to pick a winning mutual fund”. I don’t think I’ve read your post about that.

  12. Pingback: Friday Reads: Yale’s David Swensen Says Mutual Funds Are For Fish, And Stirs The Waters | The Upfront Blog

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