Monday, 10 February 2014

"In investing, you get what you don’t pay for"

I read the interesting article "The Mutual Fund Walking Dead", with the following eye-opening graph:

"The underperformance of active mutual funds is well publicized at this point.  These graphs are just another nail in the coffin.

What got my attention with this data is that it shows how many active mutual funds just completely go out of business.  Basically, they get shut down or merge with another fund.

The first study shows that only 55% of active mutual funds survived the 15 year period through 2012. Somehow, 36% survived but underperformed.  And only 18% both survived and outperformed their index.

The second graph shows how much worse active fund underperformance is once you add in the graveyard funds.  Nearly all of these asset classes go to roughly 80% underperformance against their index over 10 years including the dead funds.

In Don’t Count on It, John Bogle informs readers that there were only 49 stock mutual funds in 1945.  By 2006, that number had ballooned to 4,200.

He also shared that around 50% of the mutual funds created in the 1990s failed and 1,000 funds failed in the 2000-04 period.

So not only are you competing against simple, low-cost index funds when trying to choose active funds.  You also have to dodge the walking dead zombie funds that end up dying.

Mutual fund companies will continue to churn out funds that mirror the hottest performing sector or asset class.  If they don’t work those funds will be swept aside for the next revolutionary idea.

Don’t take the bait."

The graphs are from Vanguard, the company founded by John Bogle.

An interesting interview by The New York Times with Bogle can be found here, some excerpts (emphasis mine):

Start with the economy, the ultimate source of long-term stock market returns. “The economy has clouds hovering over it,” Mr. Bogle says. “And the financial system has been damaged. The risk of a black-swan event — of something unlikely but apocalyptic — is small, but it’s real.”

Even so, he says, long-term investors must hold stocks, because risky as the market may be, it is still likely to produce better returns than the alternatives.

“Wise investors won’t try to outsmart the market,” he says. “They’ll buy index funds for the long term, and they’ll diversify.

“But diversify into what? They need alternatives, bonds, for the most part. What’s so frightening right now is that the alternatives to equities are so poor.”

In the financial crises of the last several years, he says, investors have flocked to seemingly safe government bonds, driving up prices and driving down yields. The Federal Reserve and other central banks have been pushing down interest rates, too.

But low yields today predict low returns later, he says, and “the outlook for bonds over the next decade is really terrible.”

Dark as this outlook may be, he says, people need to “stay the course” if they are to have hope of  buying homes or putting children through college or retiring in comfort.

Too much money is aimed at short-term speculation — the seeking of quick profit with little concern for the future. The financial system has been wounded by a flood of so-called innovations that merely promote hyper-rapid trading, market timing and shortsighted corporate maneuvering. Individual investors are being shortchanged, he writes.

He is still preaching the gospel of long-term, low-cost investing. “My ideas are very simple,” he says: “In investing, you get what you don’t pay for. Costs matter. So intelligent investors will use low-cost index funds to build a diversified portfolio of stocks and bonds, and they will stay the course. And they won’t be foolish enough to think that they can consistently outsmart the market.”

He advocates taxes to discourage short-term speculation. He wants limits on leverage, transparency for financial derivatives, stricter punishments for financial crimes and, perhaps most urgently, a unified fiduciary standard for all money managers: “A fiduciary standard means, basically, put the interests of the client first. No excuses. Period.”

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