National Post columnist Andrew Coyne thinks buyers of mutual funds are suckers, as are the members of the Canada Pension Plan Investment Board, for embracing active management. He argues that up to three quarters of actively managed mutual funds have under performed their benchmark indexes after fees. He also says that the CPPIB has spent $9 billion on hiring outside active managers and added only $3 billion in performance over the benchmark index over the last seven years, for a net cost to taxpayers of $6 billion.
He is persuasive, and like other columnists thinks owners of mutual funds are suckers for paying high management fees. It’s enough to make an investor or advisor who uses these products feel like a chump.
Here’s where Andrew Coyne is wrong:
- It’s totally irrelevant that there are thousands of mutual funds that have under performed their benchmark indexes. To use a timely analogy, just because 90% of professional soccer players will never score a goal in the World Cup doesn’t mean there are no superstars who are worth the millions they get paid. The best mutual fund managers and pension fund managers earn their fees by picking the best stocks and leaving out the dogs. Think Kim Shannon, Gerald Coleman and Alan Radlo – who along with others in the top tier have a long history of outperformance. It’s a good advisor’s job to research the best fund companies, meet the managers and do the due diligence that will allow them to pick the best funds for their clients.
- Sometimes it’s not all about returns. Investors use mutual funds to reduce risk. Pension boards use active management for the same reason. How much is a 10% reduction in volatility worth, in a $189 billion dollar pool of pension assets? $1.75 billion per year? More? Less? It’s a judgment call. Some of my favourite mutual fund managers have matched or come close to their benchmarks with much less volatility than the index. Investors who buy these funds are looking for the peace of mind that comes from preservation of capital — avoiding bankruptcies or the latest fad (think Nortel, Bre-X, WorldCom and Enron) and not having to live through huge declines when the markets tank. I look at upside/downside capture ratios to find managers who smooth out the roller coaster by declining less than the indexes when the markets go down and capturing most of the upside when the markets go up.
- Investing is complicated, and part of the fee mutual fund owners pay for the management of their money goes to the advisors who help them build their portfolios and avoid behaviour that creates losses. Mr. Coyne advocates a portfolio of low-cost ETFs. What he doesn’t say is that studies show that do-it-yourself investors on average earn much less than the indexes, because they often buy and sell at the wrong times. The average ETF is only held for a few months, showing that investors who use them are mostly speculating, rather than using them as part of a long-term, disciplined investment strategy.
Where Andrew Coyne is right:
- Investors (and the CPP investment board) need to hold their managers to a high standard. Managers need to be compared to a benchmark, and fired or changed if they are not adding value by either improving returns or reducing risk. Investors should set up (or ask their advisors to set up) a #personal benchmark (see my blog entry about #personal benchmarking) that allows them to measure how their managers and their advisor are doing.
- An investor who buys a mutual fund that simply replicates an index is paying high fees for little or no value. These fund managers are closet indexers, and do little to earn their fees. An ETF or smart index fund would be a better choice than closet indexer. But managers who are not afraid to look different from the index, stock pickers who have a high ActiveShare rating, have been shown by research to add value over and above their fees (see my blog on ActiveShare ratings).
The bottom line:
ETFs can be an effective way to reduce costs as part of an overall strategy that includes active management and low-volatility funds. However, Mr. Coyne is contributing to a culture of condemnation of advisors and mutual funds by the media that has the potential to do harm to millions of investors. Columnists like Mr. Coyne who are unaccountable to the readers who follow their advice are doing Canadians a great disservice by urging them to give up their advisors and their fund managers to follow a do-it-yourself strategy that focuses mainly on fees. Calling buyers of mutual funds suckers is good copy and may sell newspapers, but it will do more harm than good. For shame, Mr. Coyne!