David Peartree, The Daily Record Newswire
The tendency to assume that the grass is greener elsewhere is a human weakness that marketing experts exploit all the time. The marketing of investment products and services is no exception.
The most common marketing angle used with investors is to suggest that there are certain ‘best in class’ mutual funds that belong in your portfolio. These are typically funds with better than average performance over the past one to three years or funds with a high rating by a firm like Morningstar or Lipper.
With mutual funds, though, “best” is an elusive category. Only a relatively small percentage of funds outperform their market benchmark over long periods of time and, of those that do, very, very few do it consistently.
Funds that deliver superior performance against their peer group year after year, never mind persistence in beating their market benchmark, are uncommon. The annual scorecard published by S&P Dow Jones Indices has documented this since 2002.
Another marketing angle is to suggest that retail mutual funds as a group are second rate and that better investment returns can be found elsewhere. This pitch offers individual investors an exclusive opportunity to gain access to institutional investment accounts that ordinarily are available only to the very wealthy or large institutions.
Understanding some industry jargon is helpful here. Individual investors of the “mom and pop” sort are known as retail investors. These are predominately low to middle wealth investors. The typical retail investor uses mutual funds to gain exposure to the markets. In the investment business, these are often referred to as “retail” funds to distinguish them from the institutional accounts that only the very wealthy individuals or large institutions have access to.
Some investment advisors offer access to institutional accounts by offering a “manager of managers” approach. By pooling the accounts of many investors, the advisor can offer access to institutional managers who otherwise might have account minimums starting in the millions. The investor opens an account with the investment advisor who then outsources management to multiple institutional money managers to cover various asset classes.
Another popular trend in recent years is for advisors to outsource to a single “turnkey asset management provider,” also known as a TAMP. The TAMP may provide investment management services itself or it may in turn outsource investment management to multiple institutional account managers.
The services of TAMPs are primarily marketed to advisors, not the end investor. They are generally promoted as an entree to more sophisticated and expert management, better than what the advisor could otherwise offer the client.
The real appeal for advisors is that TAMPs offload much of the responsibility for day-to-day oversight, trading, and reporting. They require less time and effort on the advisor’s part. The downside for the end investor is that TAMPS inevitably add an additional layer of cost. So does the manager of managers approach.
Are they worth it? Are mutual funds really second-rate investment vehicles compared with these institutional options? Do the very wealthy and large institutional investors who use institutional accounts receive better performance than the individual investor who uses mutual funds?
On average, they don’t, according to a recent report by S&P Dow Jones Indices. Over the five years ending December 31, 2015 the overwhelming majority of mutual funds and institutional accounts underperformed their respective benchmarks across virtually all U.S. stock categories. In most categories, mutual funds and institutional accounts underperformed at close to the same rates. For large-cap U.S. stocks, over 76 percent of mutual funds and over 85 percent of institutional accounts
underperformed the S&P 500. For mid-cap U.S. stocks, 65 percent of mutual funds and 64 percent of institutional accounts underperformed the S&P MidCap 400 benchmark. For small-cap U.S. stocks, over 80 percent of both types of accounts underperformed.
Among stock categories, two notable exceptions were real estate and international stocks. In both cases, a larger percentage of institutional accounts were able to outperform their benchmark. It remains to be seen how they perform over longer periods.
From past S&P Dow Jones reports we know that the number of outperforming funds generally decreases over longer periods.
For bonds, it is difficult to draw direct comparisons between the performance of mutual funds and institutional accounts, largely because they use different classifications of fixed income. Institutional accounts did better in some categories while mutual funds did better in others. The most striking difference between institutional accounts and mutual funds was in the municipal bond market. A much higher percentage of institutional accounts, 81 percent, underperformed the benchmark.
Mutual funds have plenty of flaws, but there’s little evidence that institutional accounts offer anything better on average.
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David Peartree, JD, CFP® is the principal of Worth Considering, Inc., a registered investment advisor offering fee-only investment and financial. Offices are located at 160 Linden Oaks, Rochester. david@worthconsid ering.com.
