Von Aldo

The Mutual Fund Industry Is a Scam: Says Yale's CIO

And you FAs make too much and add little-to-no vlaue. When David F. Swensen, the chief investment officer at Yale University, speaks, the investing community listens. Carefully. As CIO of Yale's endowment, Swensen has built a reputation as something of a genius, having generated double-digit returns for long periods of time. Everybody (or nearly everyone, it seems) has followed his advice: That liquidity is overrated and too expensive and not there when you need it. Thus, go for illiquid assets and non-correlating assets for alpha--ETF the market's beta. This weekend, he ripped the mutual fund industry writ large as one big self-interested scam.

In the New York Time on 13 August, Swensen authored an opinion piece, The Mutual Fund Merry-Go-Round. In the article Swensen says retail investors buy high and sell low, pay too much for active funds and would be better off indexing and going home. He also blames Morningstar for steering retail investors wrong by using its star system, which has little to no predictive value. (Morningstar has never tried to hide the fact that the star system was backword looking and has tried to tweak it to help make it more predictive, which is still isn't.) He also says that financial adviors make too much and add little value.

For more on Swensen's advice to retail investors, see his book, Unconventional Success: A Fundamental Approach to Personal Investment.

Anyway, I asked our mutual fund columnist and long-time expert Stan Luxenberg what he thought of Swensen's opion piece. Stan says: "Swensen seems to want to ban active funds, but he overlooks the positive impact of funds over the years. Before mutual funds became popular, most investors had no alternatives except putting money in the bank. Mutual funds enabled investors to get bigger returns than they ever thought possible. Funds such as American Funds Growth Funds of American and PIMCO Total Return have become huge because they have made a lot of money for many people. Many active funds have long records of beating the benchmarks with less volatility. Swensen seems to want to ban active funds altogether. But he has never used index funds. Part of the reason for his success is that he has used his position as head of the Yale endowment to gain access to the best active managers, including hedge funds that only serve select investors. He is correct that mutual fund investors buy and sell at the wrong times. But index funds are no cure for bad behavior. When markets tank, investors sell index funds. If all fund investors held index funds, the markets would still be volatile, and investors would make bad choices. He blames the Morningstar stars for the bad behavior of investors. But the reality is that Morningstar is less influential than he seems to think. Morningstar awards the best grades to funds that have delivered the best returns with the least volatility. Investors seek out such funds without consulting Morningstar. Before Morningstar existed investors were gravitating to funds with top performance. It is true that many mutual funds charge excessive fees. But the market is correcting the problem. The average fees have been falling for years."

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