October 14, 2002
An industry as competitive and highly regulated as the mutual fund industry could not possibly slip one by investors, right?
Wrong. Dead wrong, according to Gary Gensler and Gregory Baer, former assistant secretary of the U.S. Treasury for financial institutions and under secretary of the Treasury for financial services, respectively.
By their very structure of being managed by an investment advisor beholden to the funds and, in turn, by a not-so-independent board of directors with no real impetus for change, mutual funds charge whatever the market will bear, they say. Furthermore, as they note in their new book, The Great Mutual Fund Trap (Broadway Books), we've all had to write a check to our utility company, but we've never had to write out a check to our mutual fund or brokerage firm. And so, we just don't know how bad it is when they get us where it really hurts.
Diehard indexers, Gensler and Baer. They recently visited the New York offices of Thomson Media, publisher of this newsletter, to decry "The Great Mutual Fund Trap", which, they say, ensnares both professional money managers and individual investors alike. Simply put: You can't beat, you can't time and you can't tame the market.
"We took a look at every market-beating strategy out there - including buying Morningstar five-star funds or funds with good past-year performance," Gensler said. Only 20% of actively managed funds can beat the market, and nearly all have an imbedded handicap of 3% total fees and capital gains taxes against them from the get-go, Gensler said.
"Dull and boring as it might seem, it's O.K. to buy and hold, diversify and find a low-cost approach. Just go in and buy an index fund or an ETF," Baer agreed.
The two partners in anti-mutual fund crime make an entertaining, fast-talking case for their investment choice throughout their book: "We believe that the best analogy to index investing is the generic drug market" is one of the many pithy sentences throughout.
"Experience clearly shows that fund managers' stock- and bond-picking abilities usually fall short of their considerable fee-imposing abilities," Baer and Gensler write. "That's entirely predictable, given that mutual fund companies run up at least $70 billion per year in management fees, sales loads and trading costs for investors [ahead] of their attempts to beat the market."
All told, The Great Mutual Fund Trap: An Investment Recovery Plan is an eye-opening book for investors and fund executives. Gensler and Baer said they wrote the book to raise investor awareness over the ignominy mutual fund investors face every day. Let's hope leaders in the industry catch on before investors do.