I continue to be surprised by the lengths that some people will go to throw the entire financial industry under the bus. For instance, take this recent article in The Atlantic which barrels through “financial experts” by strawmanning mutual fund managers as though they represent the entire field of “financial experts”. The author pulls all the usual tricks by citing a series of studies about mutual fund managers and how badly they suck at picking stocks and how they underperform their benchmarks. The first problem here is that the author has narrowed the entire field of “financial experts” down to “mutual fund managers” even though mutual fund managers are a relatively small piece of the existing pool of financial professionals.
Worse, the author is strawmanning the mutual fund managers. Of course mutual fund managers undperform. This is only “news” to people who don’t know how mutual funds operate (ie, people who aren’t financial experts). Not only do they have cash mandates which means they don’t even replicate the benchmark they are generally compared to, but they are just generally mimicking an index (or a large component of an index) by picking stocks inside an aggregate. What I mean is that most of these managers are taking a pool of 500 stocks, picking 100 of them and then hoping to outperform even though all 500 of them are highly correlated. It’s actually amazing that even 20-30% of them beat an index given these realities. So yes, most mutual funds are terrible. But the author of the article trots this out as if it proves that all people in the financial space are just brain dead idiots.
What’s even funnier about these kinds of studies is that they regularly cite the mythical “index” as a benchmark without actually putting this in the proper context. I’ve done that and I’ve actually compared some of these studies to the one true “index”, the Global Financial Asset Portfolio. And what do we find? The indexers who demonize the stock pickers regularly underperform the GFAP! The reason why is because the indexers are generally picking an arbitrary asset allocation inside of some broader global aggregate. They are “asset pickers” with no greater level of “expertise” than the stock picking “experts” they are claiming to outsmart. But as far as I know I am the only person in the financial industry who has even pointed out the hypocrisy of the “passive indexers” who are nothing more than broader versions of the stocking picking “monkeys” they so love to hate.
But what’s dangerous and irritating about this sort of “journalism” is that you have a non-expert critiquing an entire industry while totally misrepresenting the discussion. Are most high fee mutual funds terrible? YES! Do these funds mean that all financial experts are bad at what they do? NO! But vague and generalized articles like this throw an entire industry under the bus despite the fact that there are actually very thoughtful and intelligent financial experts out there who have taken the time and effort to explore some of these matters so as to avoid making the types of dangerous generalizations that lead people to believe that the entire industry is just filled with value sucking idiots who are trying to separate people from their savings….It’s just not true. There are a remarkable number of experts in finance who add a great deal of value to people’s lives.
The bottom line is:
- When you’re looking for a financial “expert” you should know that the finance profession is a huge space. “Investment managers” generally aren’t “financial planning” experts and so we have to be careful about how we go about finding experts because someone with a broad understanding of one component of the financial industry might know almost nothing about most of the rest of the space. For instance, I would consider myself an investment expert, but I am by no means a financial planning or tax expert. If you call me for tax advice then there will be two idiots on the phone.
- When we look at “investment experts” we should be careful about how we compare their performance. If you’re going to compare mutual fund managers with a cash mandate to an index fund that no one can perfectly replicate then you might as well not even bother because it shouldn’t be remotely surprising that mutual fund managers can’t beat an index that no one else can perfectly replicate.
- When people discuss “passive indexing” they need to be very clear because picking an index allocation is an inherently active endeavor and as I’ve shown previously indexing advocates generally underperform the one true passive index of all global outstanding financial assets (which again, is nearly impossible to replicate). What’s disconcerting about this is that the advocates of “passive indexing” misunderstand their own views so badly that they don’t even know that what they’re doing is just a lower fee “asset picking” version of the same “stock picking” that they so regularly demonize.
- Most importantly, if you work with a financial expert of any type you’re probably doing more than most other people do in the first place. The vast majority of Americans don’t even own stocks or bonds which is a remarkably silly way to allocate your assets. If you’re even working with a financial expert (even a high fee mutual fund manager who can’t outperform the S&P 500) the odds are that you’re already a step ahead of the average American. And that’s half the battle. While you have to be careful about which “experts” you work with all of these experts are incentivized to get you “in the game” and that’s the part that really matters most.
* Edited out a line about the Chicago School which contributed nothing to the conversation.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.