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Scott Burns: It's Twilight For Managed Mutual Funds
I think part of the problem is that the average management fee for "actively" managed funds is between 0.5% and 1.0%. With $5.5 trillion in those funds in the U.S. it means fund companies are scalping somewhere between $28 and $55 billion from our investments every year while on average they struggle as a group to beat index funds that charge much less. They may be adding real value compared to indexing, but most or all of that value is going straight in their pockets rather than ours.
If you believe the hype that lower costs are predictive of better long term results, then it would seem active funds should reduce their costs, improve their returns and potentially take back some of the market share flowing to index funds, thereby offsetting some of the salary their losing by cutting the management fee.
I think it is a bit too much wishful thinking to assume these flows are caused primarily by fee differences or index vs active ideology choices.
A long term trend has been the demise of load funds and very high ER funds (much higher than category average). Increased investor knowledge and the replacement of such funds in 401k plans, I think, were the main drivers. Of course, most such funds were active. It is fund managers and families of such funds that should be worried. Not the funds with category average ERs whose assets seem to keep increasing even if they are 5-10x more expensive than category average of index funds or ETFs.
2008 was a watershed year for change in investor thinking regarding portfolio strategy. I believe allocation and alternate funds, as a strategy, were the winners of conscious selection rather than fees or active vs passive style as people got disillusioned with their own fund picking success. This is consistent with the flow data. I suspect this is true even amongst members of forums like this. People who have been here longer than me may be able to opine on this.
Funds of funds allocation funds like target date funds, the biggest winner as a category, primarily invest in index funds. But even those that invest in active funds like the ones from TRP have seen huge growth which suggests that it was the strategy change that was driving this than fee or management style. Target date funds have been very popular in 401k plans since they were introduced. Vanguard has benefited greatly from this flow much of which has passed on to its index funds.
In addition, index ETFs have become trading vehicles for hedge funds and alternate active funds that allow them to place huge macro bets or to play momentum with better liquidity and lower costs than picking individual stocks. I expect this to increase even further going forward also affecting fund flow numbers.
cman, you are right on. The active fund industry often uses ETFs to enhance their portfolios or to place sector, regional, or momentum bets. And they certainly use them to play out their short strategies.
Another thing that has happened, which is indeed good, is the demise of most B and C class shares, which are nothing more than cash cows for the fund and commission brokerage industry. They were shameless when they started (easy to see that in hindsight, less so at the time decades ago), and the industry fought to continue using them, all the while marketing them as 'no-load' products.
Well-managed, active funds are in no way destined to disappear. But a number of poorly-run, expensive funds will disappear, which is a very good thing. My Morningstar Office software lists more than 28,000 mutual funds this morning, many of them different classes of the same fund. Even so, there is a lot of garbage, whether it be from Vanguard, Fidelity, BlackRock, and other biggies to a lot of the small, one-or-two fund shops.
M* also lists more than 1,500 ETFs. My hunch is that 60-70% of them are pretty poor investment vehicles, too.
Burns' article says investors could managed a three-part strategy using index funds for twenty years before expenses would equal one year in actively-managed funds. That may be true, but I know of no one who would not fidget with their portfolio more than a few times a year, let alone 20 years. In, out, new strategy, out, in, change strategy, out, in, etc. That is why the average investor in any fund or ETF has a much lower net return than what the fund does.
Comments
If you believe the hype that lower costs are predictive of better long term results, then it would seem active funds should reduce their costs, improve their returns and potentially take back some of the market share flowing to index funds, thereby offsetting some of the salary their losing by cutting the management fee.
A long term trend has been the demise of load funds and very high ER funds (much higher than category average). Increased investor knowledge and the replacement of such funds in 401k plans, I think, were the main drivers. Of course, most such funds were active. It is fund managers and families of such funds that should be worried. Not the funds with category average ERs whose assets seem to keep increasing even if they are 5-10x more expensive than category average of index funds or ETFs.
2008 was a watershed year for change in investor thinking regarding portfolio strategy. I believe allocation and alternate funds, as a strategy, were the winners of conscious selection rather than fees or active vs passive style as people got disillusioned with their own fund picking success. This is consistent with the flow data. I suspect this is true even amongst members of forums like this. People who have been here longer than me may be able to opine on this.
Funds of funds allocation funds like target date funds, the biggest winner as a category, primarily invest in index funds. But even those that invest in active funds like the ones from TRP have seen huge growth which suggests that it was the strategy change that was driving this than fee or management style. Target date funds have been very popular in 401k plans since they were introduced. Vanguard has benefited greatly from this flow much of which has passed on to its index funds.
In addition, index ETFs have become trading vehicles for hedge funds and alternate active funds that allow them to place huge macro bets or to play momentum with better liquidity and lower costs than picking individual stocks. I expect this to increase even further going forward also affecting fund flow numbers.
Another thing that has happened, which is indeed good, is the demise of most B and C class shares, which are nothing more than cash cows for the fund and commission brokerage industry. They were shameless when they started (easy to see that in hindsight, less so at the time decades ago), and the industry fought to continue using them, all the while marketing them as 'no-load' products.
Well-managed, active funds are in no way destined to disappear. But a number of poorly-run, expensive funds will disappear, which is a very good thing. My Morningstar Office software lists more than 28,000 mutual funds this morning, many of them different classes of the same fund. Even so, there is a lot of garbage, whether it be from Vanguard, Fidelity, BlackRock, and other biggies to a lot of the small, one-or-two fund shops.
M* also lists more than 1,500 ETFs. My hunch is that 60-70% of them are pretty poor investment vehicles, too.
Burns' article says investors could managed a three-part strategy using index funds for twenty years before expenses would equal one year in actively-managed funds. That may be true, but I know of no one who would not fidget with their portfolio more than a few times a year, let alone 20 years. In, out, new strategy, out, in, change strategy, out, in, etc. That is why the average investor in any fund or ETF has a much lower net return than what the fund does.