Originally posted by the Huffington Post, April 18, 2017
The financial media likes to talk about the “smart money.” When doing so, they rely on pundits who often tell you what hedge funds and billionaires are doing. Here’s what they don’t report.
The unreported story
Many billionaires and all hedge fund managers make their money by managing the money of others. They’re “smart” about persuading investors they have the expertise to consistently and reliably pick stocks that are mispriced, time the market, and select mutual fund managers likely to outperform in the future. What makes them so “smart”? There’s no credible evidence they have the skill to do any of these things. You would most likely be better off in a globally diversified portfolio of low-management fee index funds.
Times are changing
You’re getting this message. According to a recent report, for the calendar year 2016, a staggering 85% ($610 billion) of new fund flows went into index-based investments.
This is disastrous news for active mutual funds and brokers who have made a great living recommending these funds. We’re now seeing articles in the mainstream financial media with headlines blaring: The Death of Active Management. Here’s the sage conclusion of the author of this article – I don’t hear anyone starting off much simpler: avoid the unnecessary costs of active management, which can rob you of 1% to 2% annually in potential returns (even more after taxes), and avoid the costs of bad behavior, which can also add up to 1% or 2% a year over time.
The gig is almost up, as investors access the wealth of information indicating lower expected returns for investors in actively managed funds. As one financial journalist correctly noted: … actively managed mutual funds charge their investors big fees while usually failing to deliver returns that beat the market.
When big bucks are involved, companies tend to fight hard (and often in a misleading way) to hold on to their market share. Here’s an argument you’ve probably heard: Active managers can dump stocks in anticipation of a bear market. Index funds have to hold on to their shares because they are required to track an index. It has surface appeal, but is belied by the data.
Vanguard recently issued a blog post debunking this myth. It examined the performance of “flexible allocation funds” from 1997-2016. These funds can invest in any asset and engage in market timing. Their goal is to outperform a designated benchmark, regardless of market conditions. Think of those who run these funds as active managers on steroids.
Vanguard examined the performance of these funds in three bull markets and two bear markets during this period. It found a majority of them underperformed a simple 60% stock/40% bond benchmark in four of the periods, in both bull and bear markets.
Don’t be fooled
Don’t be fooled — and don’t be left behind — by dirty tricks and misleading arguments. The survival of active management depends on you not knowing the data. If you did, you would vote with your wallet and join the mass exodus fleeing actively managed funds for low management fee index funds.