An Example of All That's Wrong with the Mutual Fund Industry
I opened my Wall Street Journal this morning, and on page A14 I found a fine example of everything that's wrong with the mutual fund industry.
Investors who even vaguely follow the markets are likely aware that cash has been pouring into bond funds at a record clip -- some $600 billion in 2009 and 2010. The reason for this is rather simple: after a flat decade for the stock market, which opened and closed with historic bear markets, investors are worried that putting more money to work in the stock market is simply sending good money after bad. In this environment, bonds -- coming off a 30-year bull market, and historically much less volatile than stocks -- have been particularly attractive.
But there's a problem. With that cash flowing in while interest rates were at or near historic lows, many of those investors might discover that the returns they earn going forward are much lower than those of the past.
In most industries, meeting consumer demand is job one. If American drivers want big, hulking SUVs, then it's easy to argue that Ford and GM owe it to their shareholders to crank up production of Explorers and Hummers.
But in the mutual fund industry that equation is not quite so straightforward, because what customers want (i.e. funds investing in the hottest sector) is often precisely what they shouldn't have. The issue is further complicated because mutual fund managers are bound by a fiduciary duty to act in the best interest of their fund shareholders.
So if you're a mutual fund manager, how do you react to the seemingly-insatiable demand for bond funds?
On one hand, we have managers like PIMCO's Bill Gross and Vanguard's Gus Sauter, both of whom have recently warned investors about the risks they see in the bond markets -- trying, in other words, to steer investors away from making an investment decision based largely on emotion.
On the other hand, we have advertisements like the one I saw in today's Wall Street Journal. In it, Fidelity touted "High yield without high anxiety," and highlighted four of the firm's high income funds -- precisely the sort of funds that will likely be hit hardest if interest rates rise rapidly.
Fidelity is clearly following the traditional marketing model in pushing what's hot with no apparent concern for whether or not it's in the best interest of their clients. In going that route, Fidelity is hardly unique among fund managers, nor is this a new phenomenon. If you want a fun reality check, the next time you're in your local library, browse through old copies of personal finance and investing magazines from 1998 or 1999, which were chock full of ads touting funds with triple-digit returns.
The lesson for investors is simple. Don't make the mistake of choosing an investment based upon the recent past -- letting your emotions dominate your investment decisions is just about the worst decision you can make. And towards end, recognize that most mutual fund managers view themselves as nothing more than widget manufacturers, giving the investing public whatever it wants, whenever it wants it. Thus, if you find yourself intrigued by advertisements for the fund du-jour, remind yourself that it's likely that is exactly the sort of fund you should not be interested in at the moment.
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