When I used to teach an MBA elective on capital markets, I would say that if the students remembered only one thing from the course it should be that on average active fund managers fail to beat the market and you are wasting your money paying for their advice. (I was gratified when I met a Russian former student a year after the course and she did indeed remember that point). This was based on abundant research showing how the great majority of US mutual funds under-perform the stock and bond indices that they benchmark against. Retail investors should therefore buy passive funds, either directly or via ETFs (exchange traded funds) for a much lower annual fee. Similar data exist for the UK.
Nothing has changed. A new article in the latest Journal of Economic Perspectives (which is freely available on the web, owing to the generosity of the American Economics Association, and is a fairly accessible guide to new research in economics, an excellent read) by Burton Malkiel, author of the famous A Random Walk Down Wall Street, shows the data in their depressing continuity. Over 20 years to the end of 2011 the S&P 500 Index beat the mutual funds that invest in it by 0.64% a year. For the supposedly less efficient small cap market the index beat the active managers by 1.48% a year. And the US aggregate bond market index beat active bond funds by 0.82% annually.
These fees, which in aggregate have risen with the rise in value of financial markets, account for a large part of the increase in the share of US GDP of financial services, from 4.9% in 1980 to 8.3% in 2006. This is a very large industry based on transferring rather than creating wealth. Malkiel speculates about why retail investors keep wasting their money, invoking the usual possibilities of cognitive biases and the tendency to judge some products by their price. But it’s still a puzzle. He concludes in a rather dejected way:
“The major inefficiency in financial markets today involves the market for investment advice, and poses the question of why investors continue to pay fees for asset management services that are so high. It is hard to think of any other service that is priced at such a high proportion of value.”
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