The fat lady has sung. All that is left is for the curtain to fall. That, some would say, is the condition of managed mutual funds in 2016. The evidence shows up clearly in the 2016 edition of the Mutual Fund Fact Book. Published annually by the Investment Company Institute, it is the mother lode of facts and figures on the $15.7 trillion held by domestic investment companies.
The current edition shows that indexed (non-managed) equity funds now account for 22 percent of all fund assets, up from only 9.1 percent in 2000. That figure understates the actual shift because it doesn’t account for the billions that have moved from mutual funds to exchange-traded funds.
Another illustration shows a growing flood of assets out of managed mutual funds since 2007. Where did the money go? It went to indexed mutual funds and indexed exchange-traded funds. All those lost managed assets mean less revenue for traditional mutual fund companies, fewer jobs and disappearing bonuses.
This is serious, people! Summer homes will be lost! Ski trips to Gstaad will be threatened!
So it’s not surprising that the empire of managed mutual funds should strike back. And the biggie in the empire is Fidelity Investments. Hence the publication of “Three Myths of Index Funds” on the Fidelity website in July. It’s an interesting piece, but it’s a classic case of omission and mis-direction. It contains no information that would cause anyone to favor managed funds over index funds, yet makes it sound as through index funds should be reconsidered.
Here are the three “myths, discovered through an investor survey:”
- “Index funds can spare you from market ups and downs.”
- “Index funds can provide better protection from market downturns than active funds.”
- “Selling funds during volatile times can reduce losses.”
Some investors may harbor such beliefs, but in decades of following the fund industry I have never encountered an index fund advocate who has made such arguments. More important, the “myths” do nothing to differentiate index funds from managed funds. Let’s consider each one.
Managed funds, like index funds, can’t spare you from market ups and downs. It doesn’t matter what type of asset is in the fund--- stock, bond or balanced. Sometimes it will go up; sometimes it will go down.
Fidelity argues, for nearly two pages, that active funds provide better protection from market downturns than index funds. They buttress this with appropriate figures--- active funds, on average, declined somewhat less than index funds in the last three major market downturns. They attribute the superior performance to the skill of active management.
But Fidelity doesn’t tell the whole story. Index funds do tend to trail managed fund performance in market downturns. But they also tend to gain more in bull markets. Fidelity devotes a single paragraph, with no data, to this.
The performance differences aren’t because managed funds are smart in bear markets and index funds are smart in bull markets. The difference is about cash holdings. Index funds are fully invested at all times, so they rise more in bull markets. Managed funds hold a portion of their portfolios in cash as an operational necessity, so they decline less in bear markets.
The third myth, “Selling funds during volatile times can reduce losses,” applies to active and index funds alike. There is no evidence that anyone can consistently time the market. Fidelity knows this from direct experience: it was a bad call by former manager Jeff Vinik in 1995 that tarnished the once amazing Magellan fund.
The enduring truth that cannot be escaped is that active management is expensive. It’s great for managers; it’s not so great for investors, who bear the cost. One--- just one--- indication of this can be found in a recent Morningstar article, “Revisiting 80 years of sloth.” It contains a table listing the 18 actively managed funds that have been in operation since 1935 and their rank ordered performance from 1970 to June of this year.
Only four of those eighteen funds beat the S&P 500 during the period. That indicates a 22 percent chance of beating an index with active management over a very long period. While the S&P 500 provided an annualized return of 10.5 percent over the period, the average return of these established and much respected funds was 9.6 percent.
Invested in the S&P 500 index, $10,000 would have grown to about $1,038,000. Invested at the average return of the managed funds, the same amount would have grown to $710,000.
That difference is why billions have been moving to low-cost index funds.