If the 1960s were the decade when big tobacco had to come to terms with the mountains of scientific evidence that their products are addictive and carcinogenic and this is the decade when big oil has to come to terms with the mountains of evidence that CO2 emissions contribute to climate change, when will big finance finally confront its own demons, as supported by virtually every study on the subject of cost correlation?
When I say “big finance,” I could just as easily use the phrase “big wealth management” or “big mutual funds.” You see, for well over a generation scientific evidence has been piling up that the very large majority of actively managed mutual funds lag their benchmark… and that the handful that beat their benchmark cannot be reliably identified in advance. Collectively, actively managed investment products have been getting hammered on the performance side by benchmarks and the low-cost products that track them.
It now seems pretty much certain that the most reliable longterm performance indicator out there is cost – and it’s a negative indicator. In other words, the more an investment product costs, the worse it is likely to perform, all else being equal. There’s a clear correlation, but most mutual fund companies and most advisors are still in full-fledged denial mode. As the Upton Sinclair quote goes: “It is difficult to get a man to understand something when his salary depends on his not understanding it.”
The good vs. evil subtext is just as palpable as it is with big tobacco and big oil, but that doesn’t stop the denial machine. The rejoinders from SPANDEX (Sales Pitches And Non-Disclosure Eliminate EXcellence) advisors come back at a furious pace, leaving many STANDUP advisors saddened. The howlers include, but are not limited to:
• “What matters is after-cost returns.”
(Since winners cannot be reliably identified in advance, the point is moot – sort of like saying that with lottery tickets, what matters most is that you pick the winning numbers – as if it were that easy.)
• “Low-cost products don’t pay me.”
(Neither do high-cost products, of course, but since high-cost products collect and redistribute client payment via trailers, the “my advice costs no more” line continues to dupe people. In the end, only clients pay advisors.)
• “I’m an independent advisor and the products I recommend are just as good as the ones you’re asking about.”
(If they’re really just as good and you’re truly independent, you’d be indifferent as to which product the client used and not have 99% of your assets invested in those products that pay trailers – which typically cost more even after backing the trailer out.)
• “My clients don’t think cost is important.”
(That’s rich. Do you even tell your clients about the evidence supporting cost minimization? Clients will drive across town to get a deal on a TV or microwave, but you’re telling me they’re indifferent between paying 2% or 3% on a $500,000 portfolio after you’ve told them how important cost is? Deliberately withholding material facts is hardly professional behaviour.)
In the end, it comes down to this: cost matters. A lot. Think of mutual funds as lottery tickets. A few will pay off; most won’t. Buying a benchmark is a lot like not buying a lottery ticket… and did I mention that lottery tickets are sometimes referred to as “a tax on the stupid?”