Nine months ago, i was at a meeting where a fund company executive titillated the crowd by promising to “go on the offensive” regarding the value of active management and the debunking of a number of pervasive myths. The same person has since made additional comments, but they have merely generated more heat than light.
Some myths are harder than others to dispel. One is that active management is superior to passive management. Time and again, research by myself and others has shown that the very large majority of actively managed funds lag their benchmark over long time horizons (more than 10 years) and that the handful that outperform cannot be reliably identified before the fact.
Ever wonder why no one publishes mutual fund ranking books anymore? I’ll tell you why: they don’t work. I recently looked at the 10-year numbers for a book that recommended 81 funds to Canadian consumers, and only 15 of them beat their benchmarks. Those that lagged did so by more, on average, than those that outperformed. Perhaps we could debunk the myth that fund picking is anything other than an exercise in salesmanship.
Indexing proponents acknowledge that conventional passive funds will lag their benchmarks, but add that the average passive funds lag by less than the average active fund simply because the passive funds cost less. In short, their position is that active management adds cost, not value. Nobel laureate Bill Sharpe has proven this many times over and offers his rationale on a Web site (www.financialengines.com).
Do fund companies ever give this view a fair depiction in the wider marketplace?
The executive also suggested that actively managed mutual funds were to be equated with advice. Why is that? As a matter of fact, there are lots of do-it-yourself investors who use actively managed mutual funds at discount brokerages, and lots of people who use advisors but who choose a variety of passive products to build their portfolios.
While research consistently shows that most advisors add value, it also shows that most active managers don’t. Somehow, that never comes up when most advisors and fund companies are “educating” their clients. Many advisors refer to themselves as being “independent,” without acknowledging that, because many active management fund companies collect and pay out commissions and trailing commissions, they consistently fail to recommend products that do not pay commissions or trailers. In fact, many often insinuate that qualified professional advice is free — as if MERs are irrelevant. Perhaps we could debunk those myths, too.
Later in his talk, the executive said, “We all know that strategic asset allocation accounts for more than 90% of a portfolio’s returns.” That was news to me. In two separate studies, U.S. investment expert Gary Brinson and his colleagues showed that a portfolio’s strategic asset allocation explains more than 90% of a portfolio’s variance on average.
Far from debunking myths, this guy was actually perpetuating them. He might have pointed out that actively managed fund impurities compromise asset allocation, and that most policy statements are wrong because the funds hold other asset classes.
For instance, a prominent Canadian equity fund (over $5 billion in assets) in this guy’s fund family was held out as being more stable than the index it is compared against.
Of course, the fact that the fund has been invested 60% in Canadian large-cap value stocks, 20% in U.S. value stocks and 20% in T-bills was never discussed. Of course it was more stable — strategic asset allocation explains more than 90% of a portfolio’s variance and a portfolio with three asset classes is almost always going to be more stable (i.e. less variable) than a single asset-class investment. Unfortunately, an apples-to-apples comparison was never offered up.
Why aren’t more advisors, especially those who claim to be proponents of modern portfolio theory, indignant about mutual fund impurity in the pursuit of purposeful strategic asset allocation? Perhaps we should take steps to debunk the myth that financial advisors and fund company executives understand, or have ever read, the Brinson research.
When all is said and done, there can be no doubt there are many myths that need to be debunked.
There are also many stakeholders who misinform. It’s just too bad that some of the people who claim to be part of the solution are actually a part of the problem. IE
John De Goey, MPA, CIM, FCSI, CFP is a senior financial advisor with Assante Capital Management Ltd., member CIPF and an instructor with The Knowledge Bureau. The views expressed are not necessarily shared by Assante.