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THE BLUE MONEY REPORT.
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The Blue Money Report
"The knowledge of an effect depends on and involves the knowledge of a cause."
~ Spinoza
Welcome to the Blue Money Report
Note from the Editor: Tom Madell, Ph.D. is the publisher of the Mutual Fund Trends/Research Newsletter. He has offered his comments about the state of affairs in the mutual fund industry. Dr. Tom is a frequent contributor to the column and as always, his opinions should not be considered ours. Unless of course we agree which is often the case. Be sure to follow the links he has provided to receive additional thoughts on a passion that has become a life's work, mutual funds.
Today's Commentary: 07.11.03 According to John Bogle, former CEO of Vanguard Funds,
one of the most trusted authorities on investing in mutual funds and
a strong advocate for ordinary investors, such
investors typically get poor returns on their investments. How poor?
Between 1984 and 2002, the average stock fund investor made just
2.7% per year on their fund investments! Hard to believe isn't it? Yet
this is for a period during which the S&P Stock 500 Index returned 12.2%,
a -9.5% shortfall!
Expressed somewhat differently, had the equity investor invested $1000
buy and hold in the average equity fund beginning in 1984, their investment
would have risen in value by $4420 by the close of 2002, for a 9.3% return.
But had he invested the $1000 in the S&P 500 Stock Index instead beginning in
1984, his profit would have been $7910.
But, folks, here's the biggest part of the problem: Since most fund
investors tend to buy and
sell as a function of mass psychology, which usually turns out to be wrong,
the average equity fund investor does far worse over the years
than the long-term
results had he merely bought and held his funds. So, if we track the
performance of the typical investor's $1000 made at the start of 1984, his
profit would be a mere $660, or a shocking one-twelfth of that of the
$7910 shown above for the S&P Index.
How does Bogle account for this tremendous shortfall by the average
investor? He attributes the first 3% of the annualized loss to the management
fees, costs of the higher than 100% average turnover of stock portfolios, and
other expenses incurred by the average fund. As a result of such hefty costs,
the typical fund earns, as shown above, nearly 3% less than the Index.
And what about the bigger 6.6% annual difference between the 9.3%
return of the average
fund and the 2.7% earned by the average investor in those funds? Bogle
attributes
it to too many fund choices, the great majority of which are too undiversified
to meet the typical investor's needs. Such, along with the emotions of "greed
and fear", create an atmosphere whereby people are often tempted to make
the wrong choices at the wrong times; that is, they are too avid to buy
when they should be being more cautious, and too prone to sell out when things
have been going poorly for quite a long time rather than selling just a small
portion of their holdings, as I have advocated in my writings.
(Incidentally, several of the very kind of investment problems reported by
Bogle have been dealt with in previous articles on my own not-for-profit
website.)
So what can you do to get better results than those achieved by the
average investor?
Bogle is known for his support of index funds to reduce fund costs. We agree
that this is certainly part of the solution. We also feel that you should choose
fund companies and products whose management fees are among the lowest.
But, unfortunately, indexing to the S&P 500 would not have helped you a
great deal during
the last 5 years; the total return for this itself somewhat
undiversified index
of U.S. large cap stocks has been a miserable -1.6%. And, unfortunately,
human nature, and changing financial and
personal circumstances make it all the more difficult to hold any investment
year after year for a decade or two, as would have been required to emulate the
results above.
Even if you are confident in your own research or rely on data provided by
a trusted resource, I still
recommend that you consider how the above data might be affecting how well you
are really doing
in your investments, year after year.
Tom Madell, Ph.D.
Today's Commentary: 07.07.03 Doug is a bond investor which would appear to be the seedless cousin of the equity investor. He spends his day culling tidbits from the major monthly publications and the daily market papers. He caught me watering my wife's many small gardens surrounding the house and immediately ask what I thought of the markets. His question more precisely was: "Do you think the markets will continue to move up?"
When this year ends, I replied, the markets will be up. If you jump in now although, you probably will be sadly disappointed in your personal return. I knew I could explain that only as long as he was able to stand there with the melon. Round and ten pounds is as difficult it appears to hold as the oblong shaped seeded variety.
The markets have had a pretty good run. Everything looks bullish from sentiment to mutual fund inflows. The stocks that are being traded are still too expensive but that it seems doesn't really matter. Folks seem to want to get back in the dangerous and high risk waters of the equity market without so much as a memory of the last time they went swimming. Going from cash to equities can be a wise move if the cash is paying so much less (and has been for quite some time and if inflation begins to rise, that cash will be worth almost as much as the money in the cookie jar) and the five year Treasuries continue yielding a scant 2.49%, the equity market looks safe.
But it is far from conservative. Most all of the moves have been made and a period of lateral movement is underway. On what do I base this?
The emotions of stock investors has been examined somewhat pragmatically in a new book by mathematician and professor from Temple University Dr. John Allen Paulos. Exploring the state of average returns, he found out that the average investor will not get the average return without a little luck. The foundation of his research points out that given a fair market and equal opportunity, the average investor will loss ground in more weeks than they will gain. That doesn't mean that the actual return will be poor but because investors bring their own personal emotional baggage to the process, luck is a belief that the next trading session will create another possible streak of winning. When all is fair and the equity market seldom is, you will find the markets outpacing your ability to pick and choose.
This is the type of market we are in now. The coin has been flipping positively for so long that the chances of closing the gap between winning and losing can only happen one way. That "way" is lodged in the numbers that continue to dismay even the most optimistic of investors even if they want to ignore them. Economic recoveries still need people. Those people, many of whom are unemployed, underemployed, or overworked either need to be repositioned if their industry has reshaped itself or the economy has to learn that consumerism will not be part of the next market paradigm. The earnings that are going to begin drifting in will need to reflect growth and not just survival.
If you are really asking me, I told Doug if the bond market will hold up under the weight of this rise in the equity market, the chances are yes. Not as well and certainly not without risk.
The watchword in fixed income is now safety which is odd when you consider the last great spot left in the fully valued (which means getting overpriced) bond market is high-yield. Junk as it is sometimes referred to, has seen the prices increase with the yield falling in typical bond fashion.
High yield bonds and the funds that hold them have seen an increase in concern over the safety of the issues they hold. Many of the best performing funds hold some of the lowest rated, read highest risk bonds available. With the stock market giving the first half of the year appearance as a better place to raise capital, the risk for the investor in junk has increased. The companies who receive lowered ratings are the same companies who would have difficulty raising money in an other way. Too many of these companies have potential default problems that playing this investment in any other way than mutually is tantamount to driving blind.
With the risk still incredibly high and the yield beginning to fall, chasing 7-9% returns might not be worth too much exposure. It seems that discipline will be the big winner in this arena for the months ahead. This simply means that the returns will be lower but that diminished performance will translate into a better pay for the risk.
The age old battle of load versus no-load continues in the Fidelity family as the Magellan fund, a flagship whose stature as number two (behind Vanguard's S&P 500 Index Fund) in the bulked up asset market decided to drop their front end sales load. The big question is why now? The answer is twofold: redemptions and appearances.
The Magellan fund is considered an actively managed fund although appearances are deceiving. Investors have found themselves, some unwittingly through their 401(k) plans, to be paying more for what is available in a passively managed fund such as an index. The way it works is simple. Fidelity has realized that loads are not as profitable as they once were. Folks including the 401(k) investors tend to "park" their cash and leave it. This means that the fund collects once from the investor. Left with the appearance of possibly losing potential new customers put off by these loads, dropping them seems like the right thing to do.
But there are more reasons behind this apparent altruistic maneuver. Fidelity knows that the real money lies in the fees. They are not alone in this revelation as more than one fund company has realized that the real money comes from asset gathering and the fees that are associated with this type of investing.
These funds pay their managers from investor returns and investments. These fees are charged on huge asset bases which when counted in the billions adds up significantly. The payment of performance bonuses to their managers give the distinct impression that the fund is encouraging their managers to beat the index they are closely associated with. The problem is why pay these additional fees, which Fidelity racked in to the tune of $344 million last year when a passively managed index fund, the benchmark for many of the actively managed variety, charges so much less?
How does the fund company think it will do with this new change in strategy. Cited by example from FundExpenses.com, the Contrafund and its sister, Contrafund II had similar problems charging load fees while investors voted on performance with their feet. The Contrafund dropped the load charge while II held on to the 3% front end fee. The comparisons are staggering. Both funds were bleeding outflows of cash. Since the dropped fees went into effect on the Contrafund, inflows have increased ($78 million in April) while the II fund continues to see folks walk. As long as folks are so easily duped into believing that the fund always has your best interest in mind, they will continue to play these financial shell games with your money. Dropping the load did not increase the performance or the return on shareholders investments. In fact, it did nothing but create the illusion of a better place to pay for what index investors receive for next to nothing.
The question you need to ask yourself is: Has my fund beaten the benchmark they compare themselves to not only in terms of performance but also in costs? Perhaps taking the seeds out of a popular pleasure has homogenized our belief in risk. Instead of lazily spitting seeds out of the pinkish and juicy flesh, we prefer the clean appeal of seedless growth. It may look sort of like a watermelon and taste somewhat similar, but the markets without seeds, those discarded companies who fail to have more than promises, an economy whose growth is solid not tepid, and more jobs added than lost, the current investing environment just looks like the real thing. But its not.
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