Saturday’s edition of the Financial Times opens with a screaming front-page headline, ” $3.5 billion pulled out of Fidelity funds.”
…must have been a slow news day.
The article goes on to explain that net inflows of individual investor cash into the stock market–both in the EU and the US–over the first half of 2014 have been going to index products, not to active managers.
I can see several good reasons why this is so:
1. Indexing is like cruise control. You know you’re going to get more or less the return on the index against which a given index fund/ETF is benchmarked. So you only have two variables to consider: how closely the fund/ETF is able to track the benchmark, and what its expense ratio is. There’s no fretting about an active manager’s style and strategy, or whether he/she is still running the portfolio whose historical record you’re examining
2. Fidelity doesn’t necessarily want mutual fund customers. I’ve had a Fidelity brokerage account for decades. Fidelity has never approached me, ever, to buy a mutual fund product of any type. I presume it’s because the company makes more money from having me trade individual stocks.
3. Picking active managers takes some effort. It requires having some understanding of the stock market and an ability to deduce strategy from the lists of holdings that managers report each quarter to the SEC.
True, there is Morningstar, a service which has been providing its famous “star” rankings of mutual funds for about a quarter century. Although Morningstar, disingenuously, warns buyers of its star information not to use it as the reason for picking a given mutual fund, people do pay for the rankings. So they must have a reason. Investment management companies take out full-page adds to tout their high star-ness. Inflows seek high-star funds and shun low-star ones.
Over at least the past several years, however, Vanguard points out that following Morningstar rankings hasn’t been a good idea. The index fund giant is publicizing a study it did of Morningstar fund rankings from 2011 – 2013. Over the three years, Vanguard says there was a strong correlation between Morningstar star ranking and fund performance, but it was the opposite of what the rankings suggested. One-star funds performed the best vs. their peers, two-star funds the next best …and so on, in order, with five-star funds performing the worst. Whoops!
Personally, I’ve never been a fan of Morningstar’s use of short-term volatility as a measure of the riskiness of a portfolio. My guess is that the relative stability of a fund’s NAV ends up being the most important factor in getting a high star rating. So that rating has little to do with future return potential. But I have no real idea how Morningstar could have gone as badly astray as Vanguard says.
Anyway, to sum up, if there’s any news in the FT article, it’s the (understandable) extent to which individual investors are embracing psssive investing, not the fact that they’re doing so.