How to Invest Your Money » Mutual Funds

Will actively managed mutual funds ever go away?

These days, the passive investing movement is gaining momentum faster than I get rejected for dates by attractive ladies. And for good reason. Actively managed mutual funds may sometimes outperform the index but are more often than not surpassed by their passive brethren. Math would indicate that the average fund would match the overall stock market since mutual funds are such large participants. And this is true, except for one little caveat: fund fees. The fees cover all sorts of things – like paying the advisor who sold the fund to the investor, as well as paying the fund manager and the fund’s expenses. The fees also include advertising to expand the mutual fund, as well as ensuring the mutual fund company makes a healthy profit.

It seems like every blog is touting the advantages of passive investing. And yet, millions of Canadians continue to invest in mutual funds that, thanks to fees, will continue to underperform the underlying index. Will passive investing ever make actively managed mutual funds go away? I don’t think so, and here’s why:

Marketing

Between Canada’s big 5 banks and our handful of actively managed mutual fund companies, billions of dollars are spent promoting their wealth management products. They’re clever at their advertising, never actually pushing their products directly, rather preaching a message of security. Financial security is only a few trips to the bank away, at least according to their advertising.
TD uses two old men primarily in their advertising, along with a big comfy green chair. Just go to TD, the commercials say, and you won’t have to worry about money. The old men seem pretty happy with TD’s offerings, after all, they do hang around outside of the bank.
I’m picking on TD specifically, but each bank in Canada is guilty of using the same marketing techniques. And why shouldn’t they? They don’t really care about how much investors in their products make. All they care about is driving results for their shareholders.

The way they’re sold

Let’s divide mutual fund salespeople into two groups, the people who work at banks and the people who work for separate wealth management companies like Investor’s Group.
Both groups are similar in the way they get compensated, which is a sales fee when the investor buys the fund, as well as a fee every year the investor holds the fund, called a trailer fee. Advisors are thus rewarded for getting more business.
In a bank, there isn’t much need for the mutual fund folks to go out and drum up a new business. The bank places promotional materials around the branch, especially during RRSP season, urging investors to contribute to their investments. Bank tellers are also encouraged to upsell products to people with large chequing account balances, or people who just don’t have any investments with the bank. Bank mutual fund representatives have a whole branch funneling prospects their way. So they don’t have to work that hard to sell.
Meanwhile, the independent salespeople do have to drum up business. They do the usual things to drum up business – networking, marketing, and the like, all in the hopes of increasing their assets under management and their trailer fees. With several different companies offering very comparable products, it’s a dog eat dog world out there. They work hard to get the business the banks do not.
And then we have the world of exchange-traded funds and index funds. The companies who manage them make money, but once a product is introduced that seeks to replicate a certain index, that’s it. You can only have one product per index. Since management fees on these products are minuscule,(hence making them best for investors) nobody has any financial interest to push them. Financially savvy people learn about them, while Joe Investor does not.
There’s a whole army of people selling actively managed mutual funds, and hardly anybody singing the praises of passive investing. This is starting to change, but it’s not going to be an easy fight.

A lack of education

Fellas, if you ever want to ruin a date, start talking about investments. You might catch a woman who’s legitimately interested, but for the most part, the ladies don’t care about this stuff.
Okay, to be fair, I also know a fair share of guys who don’t give two hoots about investing either. People can’t be bothered to learn even the basics. The terminology is hard. The content is boring, and often too math-y for people. People just aren’t interested in learning about how to be better investors.
Then comes along the friendly mutual fund salesperson who caters nicely to this attitude. Don’t worry about anything, they say, just give your money to me and some smart investment type people will manage it. This appeals to somebody with little investing education, so they’re happy to oblige. Some might call it preying on the uninformed, but banks call it good business.
Until everybody becomes better educated financially, I don’t envision actively managed mutual funds with high fees to go away. What do you think?

Comments

  1. krantcents

    Sales people (commission) keep actively managed investments alive. The more we know about money, and investments, we make better choices. The rluctance to learn about this is surprising.

  2. Joe

    It’s terrible to see the average Canadian get completely bilked by actively managed funds. Look at most of the big ‘dividend aristocrat’ type funds, and they’re essentially a TSX 60 index with a 2% management fee.

  3. JT

    The efficient market hypothesis wouldn’t exist if everyone were invested in index funds. I can only imagine how insanely high the S&P500 would be valued and how low everything else would be valued if EVERYONE were to adopt a “passive” portfolio of funds.

  4. funancials

    The mutual funds being sold in banks certainly won’t go away. Mainly because its not a decision between mutual fund or index, its between
    mutual fund and a CD earning next to nothing.
    Every single book I read keeps telling me to ditch mutual funds for the same reasons you have listed above. Only problem is, I’ve had a string of great luck with my selections. If 75% of mutual funds underperform the index, I’ve been in the top 10-25% everytime. We will see when this streak ends…

  5. Monevator

    It’s a catch 22 — for passive funds to be more widespread, they’d have to advertise more, and ultimately that would slowly increase their costs.

    That said, I think companies like Vanguard are getting to the size where they can get the message out very cheaply, without passing on more than 0.01% or what have you to their tracker consumers. 🙂

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