Photo by Matt Briney on Unsplash
What would it take to get you to stop doing business with active managers? Let’s first define the term. “Active managers” are fund managers, brokers and registered investment advisors who believe they can “beat the market” by stock picking, market timing and selecting actively managed mutual funds.
The phony “debate”
There’s no legitimate debate about the merits of active vs. passive management. The only ones “debating” this issue are those who are economically dependent on the perpetuation of the myth of active management. Primarily, these advocates include active mutual fund families and the securities industry (brokers). The last thing they want you to understand is that active management is the greatest wealth transfer scheme the world has ever known.
Without getting too deeply into the weeds, consider these facts:
- Most actively managed funds underperform their benchmark index every year;
- Over the long-term (10-20 years) the chance of an actively managed fund outperforming is statistically insignificant;
- Outperformance doesn’t persist;
- No one has figured out how to identify outperforming funds prospectively.
The “efficient market” straw man
Proponents of active management are fond of arguing that passive management is premised on the “efficient market hypothesis”, which states that it’s difficult to “beat the market” because new information is quickly incorporated into the price of publicly traded stocks.
Why is this a straw man? Because it doesn’t matter if the market is perfectly efficient or not. The reality is that your broker is unlikely to find — much less exploit — any perceived inefficiency.
Only about 11 percent of trades are retail. The majority of trades are from high frequency traders. The balance are done by institutions and hedge funds. If there are inefficiencies in the market, these large, well-financed institutions, with their super computers, are likely to exploit them before you and your broker can press the “buy” button.
Will nothing deter you?
The securities industry is so confident in your loyalty that it makes stunning disclosures that should deter any investor. It’s confident you will pay no heed. Here’s one glaring example.
On December 31, 2014, J.P. Morgan came out with the J.P. Morgan Efficient Plus DS 5 Index (net ER) Fund. It describes the complex strategy of this fund, in part, as follows: The fund “seeks to provides (sic) exposure to a range of asset classes and geographic regions based on the modern portfolio theory approach to asset allocation.” The index it created has exposure to different asset classes and “targets” an annualized realized volatility of 5% on a daily basis...”
Among the many risks disclosed is this astounding one:
JPMS is under no obligation to consider your interest as an investor with returns linked to the index.
What does that mean?
It would seem that JPMS can consider its own interest and place it above yours, at least with respect to “returns linked to the index.”
Why would you give your hard earned money to a fund manager who tells you upfront that it can resolve some conflicts of interest against your best interest?
It gets worse.
Almost all brokers have a mandatory arbitration clause in their customer agreements, requiring arbitration administered by FINRA. Many, including me, believe these arbitrations are biased and rigged against investors.
Investors in this fund get a double whammy. The fund manager can ignore its best interest and, if the investor believes it has acted improperly, the investor has given up his or her right to access to the courts. No jury trial for you!
Buyers of this fund, among many others, validate my concern that investors in active management are fine with transferring their wealth to those who “manage” their money.
The views of the author are his alone. He is not affiliated with any broker, fund manager or advisory firm.
Any data, information or content on this blog is for information purposes only and should not be construed as an offer of advisory services.
Get Dan’s investing insights by signing up for his free, weekly newsletter here.
Follow Dan on Twitter: www.twitter.com/DanSolin
Watch Dan’s new YouTube investing channel.