The Mutual Fund Industry Wealth Transfer

David Swensen, the chief investment officer at Yale University and the author of "Unconventional Success: A Fundamental Approach to Personal Investment," wrote an opinion piece on the mutual fund industry that appeared in The New York Times over the weekend. It's quite an indictment of an industry that offers products that are used by millions of investors.

In the article Swensen makes several important points:

• The mutual fund industry has failed to deliver on its promises of market beating returns. Very few actively managed funds outperform the market itself.
• Mutual funds are for-profit enterprises which means that there is an inherent conflict between their incentive to generate revenue and the investors desire to earn returns.Virtually every dollar earned by a mutual fund comes directly from its shareholders. This is a zero sum game.
• Investors are lured into buying funds that have achieved high praise by mutual fund industry monitors such as Morningstar and Lipper. Unfortunately, such recognition is for historical results. It has nothing to do with what the fund will do in the future. Academic research tells that those funds that have performed well in the past may well underperform in the future. The phenomenon is known as "reversion to the mean."
• Investors are prone to investing in hot funds only to find that they soon lag their peers. Many investors grow disillusioned, sell the once stellar fund and move on to the next hot fund. It turns out that funds often experience cycles of both superior and inferior performance. They follow each other (imagine the sine curve). Investors buy high and sell low and thus lock in results that are actually far worse than the funds they own. Dalbar has provided research on this for many years. It tells us that mutual fund investors do not come close to earning market returns. It also tells us that investors keep their funds for just over 3 years. Hardly a long term strategy.
• Swensen tells us to "invest in a well-diversified portfolio of low-cost index funds." He points out that if investors had held their funds for 10 years, their results would have improved by 1.6% per year. This is a dramatic improvement in an industry that measures performance in basis points. (There are 100 basis points in one percent.)
• Swensen also calls on the Securities and Exchange Commission to do more to regulate the mutual fund industry and protect investors.

Here's the link to the article:

The Mutual Fund Merry-G0-Round

I encourage you to read the article. I suspect those who do will find the case for Intelligent Investing - low-cost, passive investing - even more compelling.