An average investor visiting the Morningstar Investor Conference in Chicago last week would have come away thinking their portfolio was a mess.
Fund companies were hyping their alternative investments, smart-beta index issues and every new bell, whistle and sparkle. Money managers were talking about strategies for reducing risk and volatility, and seemingly every fund firm in the exhibit hall was celebrating five-year bull-market records with performance so great that it seemed beyond the reach of ordinary investors.
But no amount of careful industry preening compensates investors who have been nervous and scared after suffering through the cataclysmic downturns of 2000 and 2008.
All the shiny new toys are hard for investors to understand, let alone use properly, and the fund industry seems less focused than ever on doing what’s right for consumers when that path is at odds with what’s most profitable.
Attending the Morningstar event for the first time since 2011 (having attended for each of the prior 17 years) made me recognize some things fund companies must to help investors remain comfortable that they’ll come away with a good and fair experience.
Sadly, fund companies (and regulators and the industry in general) mostly won’t do these things, so protect yourself if these issues hit home with you:
Disclose how different funds are from the index they are measured against. While benchmarking is required — funds must show their performance against a relative index — the industry is all abuzz about “active share.”
Active share, a concept created by academics, compares what’s in a fund’s portfolio to what’s in the most appropriate benchmark. The more the fund deviates from the index, the higher its score should be; the lower the active share, the more likely shareholders are getting a “closet index fund,” where the investor pays higher costs for active management but gets results like a lower-cost index issue.
Fund companies are all over these measures internally; they should share them with the public, so that investors who pay up to get active management know they may achieve the benefits.
Stop the gimmicks. There’s a fine line between what sounds terrific in theory and what works in application, and the fund industry is a copy-cat game where every potential idea is mimicked, tweaked and enhanced but where few of the “next great thing” lives up to the hype.
New is not necessarily improved; fund firms have convinced a lot of average investors to make their financial lives needlessly complicated. It pays off for the fund firms but not for consumers. At this point, the investing public could get by for a hundred years without a single new fund, so fund firms should create new issues carefully. Because fund firms can’t help themselves on this front, consumers should avoid anything where they are not clear on how the fund is useful and how it can deliver on its promises.
Shut funds where asset growth has affected strategy. I spoke with two managers at the Morningstar event who were opening new funds largely because of the success of their last issue; specifically, both said that as their initial fund had grown, the smaller stocks that they were most passionate about no longer could have a big impact on the fund’s performance, so they were starting new funds that could get that boost.
The established funds are now at a point where their size makes them virtually incapable of recapturing the glory days of their past performance; investors should be angry (or at least considering going to the new funds).
Management, at some point, needs to stop taking new money to protect the investors it already has; too few fund companies do it.
Agree to use a common language. It’s hard enough to discern what a term like “value” means when that style means different things to distinct managers, but now we have “smart beta” or “strategic beta” funds — the latest buzzwords — or “lifestyle” versus “life-cycle,” and every fund company comes up with its own interpretation for what the words mean.
Every fund company wants their products to sound unique, but all that fluff does is confuse the public, because each purported “new idea” is typically a small twist on something that has been done before.
Stop trying to redefine the business. Every fund company says investors should not buy products they don’t understand; if the industry can’t define what it does well and clearly, it doesn’t deserve the trust of the public. It needs to build that trust rather than shave it down with each new issue and concept.
Kill funds that can’t achieve economies of scale. Expenses matter, and if it’s in a fund company’s interest to launch a new issue, they should be willing to foot the bill. So either seed the funds with enough dollars to bring costs down significantly — $50 million or so achieves critical mass — or kill off the issues that can’t reach that level (better yet, $100 million) to where costs become reasonable.
Shareholders should not be paying for fund firms to fiddle around hoping an idea pays off.
Chuck Jaffe is senior columnist for MarketWatch. He can be reached at cjaffe@MarketWatch.com or at Box 70, Cohasset, MA 02025-0070.