SAN DIEGO (ETFguide.com) - Even though stocks have surged since
their March lows, many mutual fund managers and their investors
have been falling behind. This is explained, in part, by the latest
S&P report card of active managers versus S&P indexes.
Over the past 5 years, Standard & Poor's reports 68.75% of
active large cap funds failed to beat the S&P 500 index
(NYSEArca: SPY), 75% of active mid cap funds failed to beat the
S&P MidCap 400 index (NYSEArca: MDY) and 67.37% of active small
cap funds failed to beat the S&P SmallCap 600 index (NYSEArca:
How can you avoid falling behind?
Don't Distort the Data
If 75% of active funds are outperformed by an index, don't twist
the data to make it something it's not. The financial lesson you
can take from this, is not that investors need to pick their mutual
fund managers more carefully as those that suffer from data
misinterpretation deficit would conclude. Here's the real lesson:
Trust the indexes and the financial products tracking them, not the
portfolio managers that try to beat them and fail. Translation:
Align your money with winners not losers.
If you own mutual funds, isn't it time you found out how your
funds have really performed versus corresponding index funds and
'The belief that bear markets favor active management is a
myth,' stated the S&P report. The analysis also revealed
similar results of bear market underperformance by mutual fund
managers during the last downturn from 2000 to 2002.
If you still choose to invest in active funds or individual
stocks, be sure to do it with extra money that you don't care
about. Your serious money should be invested in a diversified mix
of low cost index funds.
One of the key problems with mutual fund management is their
convoluted business practices of rewarding failure. Instead of
punishing bad behavior, they reinforce it. For example, in 2008,
Mario Gabelli vacuumed in a $46 million paycheck from GAMCO
) even though client assets at the firm fell by 33%. Despite the
worst economic and market conditions of our generation, Wall
Street's fund executives are still cashing in like a bear market
never happened. Mr. Gabelli is a Barron's roundtable contributor
and he presides over funds such as the Gabelli Equity Trust (
) and the Gabelli Asset Fund (Nasdaq: GABAX).
'Having a mutual fund management company is like having a
toll booth on the George Washington Bridge all for yourself,' is
what Marty Whitman, manager of the Third Avenue Value Fund (Nasdaq:
TAVFX) told Forbes Magazine.
If that's true, it looks like John Bogle's 'Designing a New
Mutual Fund Industry' will have to wait a few more decades. Sorry
Jack. In the meantime, all investors should immediately start
re-designing their own investment portfolios to avoid getting
Who's Protecting Who?
Instead of protecting mutual fund shareholders as they should be,
mutual fund titans have resorted to 4th grade techniques, namely,
finger pointing. In a recent letter to mutual fund shareholders,
the Chairman of Fidelity Investments Edward C. 'Ned' Johnson III,
gave the financial services industry a severe verbal
'Although we ended 2008 better than a number of financial firms,
it was a year of painful experience for the financial services
industry, a period laced with toxic investment waste and the casual
use of other people's money by a number of institutions,' Johnson
What Johnson failed to mention in his criticisms was the most
interesting of all.
Did you know that Fidelity's fund managers more than doubled
their ownership stake of floundering bailout kid, Citigroup (
) during the fourth quarter of last year? As Citi was sinking, so
were Fidelity's equity mutual funds. In 2008, 64 percent of the
firm's stock funds were beaten by its peers. Is this the 'toxic
investment waste' Fidelity's Chairman was referring to?
In contrast, index funds and ETFs have been 'protecting' their
shareholders during this vicious bear market. How? Quite simply, by
not doubling and tripling up on dead-beat stocks like Citigroup. By
design, stocks with the lowest market capitalizations have the
least amount of influence on the performance of an index.
The Performance Chasing Mafia (
There are others who claim they can find mutual funds that do beat
the market. I classify them as official members of the performance
chasing mafia or 'PCM' for short. They remain utterly defiant (and
aloof) about the relevant statistical facts, because they know
Take for example, Adam Bold, founder and chief investment
officer of The Mutual Fund Store, a chain of 70 fee-only financial
advisers. He recently told Bloomberg, 'I'm a believer that by
indexing, you're accepting mediocrity. There are a limited number
of people who have shown an ability to consistently beat the market
year after year.' Earth to Adam! Earth to Adam!
The problem, which Mr. Bold doesn't address, is that it's next
to impossible to accurately pre-identify top performing fund
managers before they become top performing fund managers. That
leaves people like Bold with one choice: To chase historical
performance. Investors almost never get what they bargained for and
performance chasing advisors get lots of fees. Nevertheless, Bold
has made himself a very successful Wall Street career in helping
people to identify yesterday's winners, as his $4 billion
Finding Better Alternatives
Index ETFs are the solution to avoiding underperforming mutual
funds. If you don't want to be limited to ETFs that follow S&P
stock indexes, there are other excellent choices to consider.
Forexample, Vanguard's ETFs follow MSCI constructed indexes,
which generally tend to be broader and more diversified because
they own more securities. See the Vanguard Large Cap ETF (NYSEArca:
VV), the Vanguard MidCap ETF (NYSEArca: VO), and the Vanguard
SmallCap ETF (NYSEArca: VB). All of these Vanguard ETFs charge rock
bottom annual expenses that range from 0.07% to 0.13%.
By aligning your money with the index funds, you avoid becoming
a victim of systematic market underperformance. And while the rest
of the investing population falls behind, you can get ahead!