The (Rejected) Introduction
Nonetheless, it wasn’t bad for having been kicked to the wayside. Over the next week, I will be giving you a look at this unused material before we move on to the actual chapter by chapter look at the book and some of its many analogies.
Introduction: What went Wrong with Something so Right?
Regrettably, I have to agree that Peter B. Farrell of MarketWatch.com was right on the money when he skewered mutual funds in a column he published online recently. Once the investment that occupied the quiet corner, these all-but-ignored funds have developed some bad habits while we weren’t looking. And despite all of the regulation that governs these investments, they have found a way to create a bad reputation.
For some, it was well deserved. For others caught in the sweep of negative glances from the public and scrutiny of regulators, the fallout was overdue. And yet, they are doing little to change the current public perception of mutual funds as anything other than a necessary evil tucked inside a retirement plan.
Mutual funds are, for want of a better description, a somewhat nefarious and deceptive investment that are run by managers – men, women, teams and/or computers that often seem, at least of late, to be using them only as incubators, auditions in some respects for the real money to be earned sometime down the road when they create a hedge fund of their own. This “land of opportunity” bravado that our mutual fund manager may embrace, works and is largely tolerated when he/she/them/it is focused on the reason we hired them in the first place. But when he/she/them/it puts their interest in the fund too far to the forefront, then you can pretty much rest assured that his/hers/their/its bravado may not serve our interests.
It would be nice to say the mutual fund industry wasn’t always so ‘cloak and dagger’, but to some extent, it always has been. Funds, the people or machines (which have people behind them), or the companies behind the fund companies (often publicly held entities who are beholden to yet another group of shareholders) try to hold their most intimate details close.
Maybe its just me but they seemed to get even more secretive in light of the sheer number of new private investment groups like hedge funds that have exploded on the scene of late. Worried that the competition might get a “leg-up” on some sort of investment style, they dodged transparency in favor of opaque strategies.
Fund managers and the funds they run have always been a somewhat shadowy enterprise but now they seem to be more so. This does not bode well for investors who, study after study have proved to be easily swayed by a certain name, a perceived image of the strategy they employ, or the overall empathetic approach or goal their advertising employs and practically promises to deliver.
Sure, there are secrets to guard. The kind of stocks held in a fund’s portfolio, in a world changed by the Internet, is as close as your computer. There are a finite number of stocks and equity offerings a fund can invest in and, with a good computer processor, there are only a finite number of ways they can invest in those stocks. Your access to what they hold is usually limited to the top ten stocks in the portfolio. Once on the inside however, and you have the entire portfolio – or at least a list of holdings from the last quarter – in the prospectus.
Mutual funds have created the questions investors are supposed to ask. “Which index do you compare fund YYYYX to?” an investor has been conditioned to ask. Until the creation of the first index fund in 1975 by legendary investor John Bogle of the Vanguard Group, where funds harder to buy? Did indexes really change the industry to such a degree that we could not determine who did better than whom at any given moment? But is asking about who to best use as a comparison even the right question? How hard is it for an actively managed mutual fund to pick an index? By actively, which I will discuss throughout the book, I refer to a fund whereby the managers, be them man, woman or machine, trade their underlying holdings based on some charter the fund is supposed to follow and to do so in pursuit of making money.
Can it be done? Should it be done? They are, in a sense, comparing apples to oranges, actively managed stock portfolios to relatively fixed ones and then they expect us to take those considerations into account and pick a winner. Should a fund manager pick the right index to use for comparison however and magically you can be considered good or perhaps even among the best.
Is an actively managed fund only as good as the index it uses for comparison? Or is there something more? Imagine how many potential investor you might attract and what current investors might do should you improve your rank among your peers. Imagine the bragging rights you would have and all the fund needs to do is beat that benchmark.
To be counted among the best, you need to do it consistently and succeed in besting that mark over a period of time that should encompass years. But we will discuss all of that later on. We will also include a discussion on those indexes as well, a not-so stagnant pool of holdings that has recently shifted shapes, a feat that further confuses the investment waters we are attempting to navigate.
Don’t misunderstand me. I love mutual funds. Always have. Which is why I tend to be critical of them. That criticism will show through at times but it is only because I don’t see the reasons behind some of the things the industry does.
The next post begins with the following phrase: “Then, there is the cost of doing business.”
