There is a saying among the DIY community to buy the issuer and not the product. In other words, you are better off profiting from the investment follies of others than to become a fool yourself. It has also been a long standing opinion that the financial industry is rifle with conflicts of interest. What happens when these two concepts collide?
William Bernstein in his excellent book, The Investor’s Manifesto, looked at the performance of mutual funds issued by publicly traded, private and nonprofit firms. He tabulated the percentage of mutual funds which received 4-5 stars by Morningstar (a good rating) and those which received 1-2 stars (a bad rating).
Of the 18 firms he profiled, 5 were not publicly traded. They placed 1st, 2nd, 3rd, 6th and 9th. Positions 10-19 are littered with big names like Goldman Sachs, ING, AIM Invest and John Hancock; likely big names because they sell high-fee product delivering poor performance to the investor but with large profile margins to the issuer. Putnam, the much troubled shop owned by Power Financial, placed dead last.
The lesson being not to buy mutual funds from publicly traded firms.
The explanation is straight-forward. Take a look at all the stakeholders a mutual fund issuer has to deal with on a daily basis: regulators, shareholders, debt-holders and customers. Short of fraud or regulatory non-compliance of a material nature, who has the ability to hire or fire the directors and officers of a company?
Right- it is the shareholders. So who’s interest will a mutual fund company tend to first? The shareholders by delivering profit quarter after quarter. In and of itself, this fact is not good or bad. It only has a bad meaning if one happens to be a customer being sucked of every dollar the company can part from you. It has good meaning if one owns the stock but not the product. If one happens to own both the stock and the mutual fund the company issues, essentially, one is taking money from the right pocket to place in the left pocket and things more or less even out although with a love/hate relationship as shareholder/mutual fund holder.
Lest a ETF supporter beat his chest proudly and declare “another reason to pick ETFs over mutual funds,” we stand at an interesting point in history. Those who have followed ETFs for the last 3-5 years are slowly watching an industry being eroded by the excesses of the industry.
As the mutual fund industry goes sideways, more financial service firms are simply buying ETF issuers or becoming one themselves spreading “mutual fund-itis” with symptoms such as fee creepage, overly exotic products and an over- emphasis on the intermediary’s interest rather than the investors.
The remedy to mutual fund-itis is to be educated, aware and keep things simple.
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