Morningstar Advisor - October/November 2013 - (Page 80)
Phillips Curve
The Good Guys Win
By Don Phillips
Whether one views the fund industry as in
decline or in a prolonged state of improvement
depends on one’s time frame. Jack Bogle
makes a compelling case for decline in The
Clash of the Cultures, in which he cites the rise
in fees and the deterioration of stewardship for
funds like Massachusetts Investment Trust and
Putnam Investors as their management
companies moved from partnerships to
corporate conglomerates. To Bogle’s thinking,
the rise of corporate ownership has been
a catalyst for subjugating the best interests
of investors to the need for rising profits for the
manager. It’s a bleak picture. It’s hard to
imagine an investor who would opt for the
current versions of many of the industry’s
pioneering funds over their former structures
and pricing.
I bow to no man in my respect for Bogle’s
knowledge of the industry. He has studied
it with an eagle eye since his undergraduate
days at Princeton. But this impression of
inexorable decline doesn’t jibe with my more
limited perspective. I’ve been a fund investor
since the 1970s and a fund researcher
since the 1980s. Over the decades that I’ve
followed the industry, I see steady, albeit
non-linear, improvement. While the industry
is by no means perfect, today it offers
investors more low-cost, good-stewardship
opportunities than ever before. Moreover, the
range of good-quality investment choices
facing an investor has never been greater.
Financial advisors and their clients have a tool
kit today that exceeds that of the top institutions just a decade ago. Fees have come
down. Stewardship, as evidenced by manager
investment in the funds they manage, is on the
rise. Transparency of expenses and holdings,
80 Morningstar Advisor October/November 2013
especially for funds domiciled in the United
States, is at an all-time high. In short,
no sane person would trade the fund options
of today for those of the 1980s.
Don’t believe me? Let’s revisit some of the
practices common among funds when
I started at Morningstar. Loads of 8.5% were
the norm. Charging investors full loads
to reinvest their income distributions was
practiced by several major fund companies,
including Franklin Resources. Contractual plan
funds that deducted up to 50% of the
first year’s investments were promoted by
major firms like Fidelity and AIM. Funds did not
have to disclose manager names, and many
firms hid behind a management team tag
or played games with start dates to make their
managers look more senior than they were.
Fund companies effectively choose their
own peer groups, leading to scores of “number
one in category” claims that owed simply
to miscategorization. Funds were promoted and
sold largely on the basis of yield and those
“yields” were often inflated by short-term
capital gains or return of capital. Worse still,
this promotion of yield led to a veritable trail of
tears as fund companies wooed investors
enticed by double-digit yields into increasingly
risky waters, moving from money market to
government bond to option-enhanced
government bond to corporate to high yield to
complex multimarket bond strategies.
Nowhere were investors more poorly treated
than at the big wirehouses, which dominated
the fund landscape in the 1980s. Responding to
client pressure to sell “no-load” funds,
these firms began the aggressive promotion
of B and, later, C shares, which sought to
overcome client resistance to loads without
sacrificing any compensation to sellers.
In addition to running expensive funds, the
wirehouse firms launched gimmicky ones that
often blew up on clients. Bogle may think
corporate ownership is bad for fund management, but I’d maintain that there’s no worse
structure than to have a fund manager
being owned by a company with a heavy sales
culture. Firms like Dean Witter were abhorrent
stewards of fund shareholder capital.
Today’s fund landscape looks little like the
1970s. The wirehouses are all out of the
asset-management industry. Asset flows go
almost exclusively to funds with lower fees and
better stewardship. Bogle’s own shop,
Vanguard, has become a towering force in the
industry. One can argue that change happened
not out of goodwill from the participants,
but by the discipline of advisors and investors,
but in either case, the result is that shareholder-friendly tactics have won. The single best
indicator of whether an asset manager gained
or lost market share over the past three
decades is whether or not it launched an
Internet fund. In short, the good guys have won.
Bogle acknowledged this to some degree in our
recent conversation at the Morningstar
Investment Conference, responding positively
when I asked him if in 50 years the industry
would be more of a profession and less of a
business than it is today. I’d add that the key to
that goal will be an informed and demanding
shareholder base. In the end, we’ll get the fund
industry we deserve. If we are good stewards,
we’ll receive good stewardship in return. K
Don Phillips is head of global research
with Morningstar.
Table of Contents for the Digital Edition of Morningstar Advisor - October/November 2013
Morningstar Advisor - October/November 2013
Contents
Contributors
Letter From the Editor
How to Make Social Media Work for You
Do Mutual Funds Still Have a Role?
More Personal Than Finance
How to Handle Your TIPS Positions
A Real Estate Veteran Starts From Scratch
Investments á la Carte
Investment Briefs
When to Say No
Take a Guarded Approach to Homebuilders
Fund Distribution Has Been Turned on Its Head. Now What?
Winning the Distribution Battle
Active ETFs Wait for Their Heyday
A Fund Firm Defies Indexing Trend
Piloting New Channels
A Good Fit
The Predictive Power of Fair Value Estimates
Does Being Prudent Pay Off?
Utilizing Utilities’ Total Return
Stuck in the Middle Is Not a Bad Place to Be
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
The Good Guys Win
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