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A recent article in Morningstar illustrated the irrationality (some might call it “insanity”) of investors. It discussed the aggregate performance of a composite of actively managed mutual funds from a fund family called Stadion. These funds had assets of more than $650 million.
Over the 14 years of their existence, the funds studied barely beat inflation and underperformed their “prospectus benchmark as well as the S&P 500 and Bloomberg Barclays U.S. Aggregate Bond indexes.”
That’s bad enough, but here’s the data point that got my attention. The funds generated $115 million in fees. How did the shareholders do? They earned only $160 million in income and gains over the lifetime of the funds.
What’s the trading strategy that accounted for this debacle? According to Morningstar, it appears to be a witch’s brew of market-timing, combined with “trend-following and technical indicators to ‘react’ to the market.”
Morningstar notes the ability of Stadion, through complex maneuvering, to survive and collect fees. It cautions investors to give it and its funds “a wide berth.” However, there’s a bigger lesson to be learned here.
A bigger lesson
I have no reason to believe the fund managers at Stadion are more or less talented than those at any other fund family. Almost every actively managed fund engages in some form of market timing, stock picking, tactical asset allocation, or technical analysis.
If you’re investing in a mutual fund that is attempting to “beat the market” using any of these strategies, what confidence do you have that your fund’s performance will not mirror Stadion’s? The Morningstar article notes that “regulatory protections and transparency aren’t a substitute for due diligence”. But what ”due diligence” are you supposed to do?
What due diligence is useful?
Looking at the past performance of a mutual fund isn’t enough. Mutual funds are required to caution investors that “past performance is not indicative of future results.” There’s compelling data supporting this admonition. Outperforming funds are statistically unlikely to repeat their stellar performance from year-to-year or over the long term.
Here’s due diligence that would be useful. There’s a mountain of data indicating the underlying investment strategies employed by Stadion and other active fund managers generate results likely to underperform their benchmark indexes. This research is set forth on this web site in great detail.
I can save you the trouble and give you the bottom line: There’s no credible evidence anyone has the expertise (once you account for luck) to reliably and consistently ”beat the market” using any of the strategies employed by Stadion (and others), especially over the long term.
Stadion isn’t unique among active mutual fund managers in transferring a significant portion of the appreciation of its funds to its own coffers. According to Vanguard founder John Bogle: "When our financial system — essentially our money managers, marketers of investment products and stockbrokers — put up zero percent of the capital and assume zero percent of the risk yet receive fully 80% of the return, something has gone terribly wrong in our financial system."
While I feel the pain of investors in Stadion funds, the problem is systemic. In my view, investing in any actively managed fund (or in a portfolio of actively managed funds), given the low odds of outperformance, (especially after taxes) is a variant of investor insanity.
The views of the author are his alone. He is not affiliated with any broker, fund manager or advisory firm.
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