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Swensen on the mutual fund industry

In an earlier post we took a critical look at the consequences of Mark Cuban’s advice to individual investors. The upshot was that Cuban was advocating market timing in the guise of “invest in what you know.”

In an op-ed in today’s New York Times the head of the Yale University endowment David Swensen took to task the mutual fund industry for it’s many failures to protect individual investors from their own worst mistakes.  He thinks this is due in part to the conflict of interest between for-profit money management and their duty to investors.  Swensen writes:

The companies that manage for-profit mutual funds face a fundamental conflict between producing profits for their owners and generating superior returns for their investors. In general, these companies spend lavishly on marketing campaigns, gather copious amounts of assets — and invest poorly. For decades, investors suffered below-market returns even as mutual fund management company owners enjoyed market-beating results. Profits trumped the duty to serve investors.

One of the industry’s failures is the marketing the performance of highly volatile funds.  Unfortunately individual investors are notoriously poor market timers who see their rate of return, due to poor timing, fall way behind the headline numbers.  Swensen writes:

Highly volatile technology funds, for example, generated annual returns that were a stunning 13.4 percent below the reported results, as a direct result of monumentally mistimed buying and selling. Holders of less volatile conservative allocation funds suffered only a 0.3 percent annual deficit.

Swensen would like the SEC to take a more activist role in regulating the mutual fund industry and to hold the industry to a higher fiduciary standard.  His advice for individual investors is not altogether new or novel but in light of the ability of most individual investors to effectively manage their portfolios it is likely the best possible solution:

First, individual investors should take control of their financial destinies, educate themselves, avoid sales pitches and invest in a well-diversified portfolio of low-cost index funds, like those offered by Vanguard, which operates on a not-for-profit basis…Such a strategy reduces the fees paid to the parasitic mutual fund industry, leaving more money in the hands of the investing public.

That is ultimately the goal – leaving more money in the hands of the investing public.  Some investors are willing and able to beat the market.  For the broader public a less conflicted mutual fund industry would go some of the way to helping investor keep more of their hard earned money.

Update:  Henry Blodget at Business Insider has weighed in on the topic noting “The fund industry costs investors billions in lost returns every year–while coining money for itself, its employees, and its distributors.”

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