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Matt Levine- Money Stuff: Nobody Wants Mutual Funds Now

It feels like there are two dominant retail investment strategies:
1. Buy and hold index funds, or
2. Actively trade individual stocks and, while you’re at it, maybe options or crypto.
Many ordinary people do not want to think about their investments much, and modern finance has designed a product that is ideally suited for them. It is the index fund (or index exchange-traded fund), whose essential thesis is that thinking about investments is unnecessary and in fact bad, and you should just buy the market and save on costs.

Other people, though, do want to think about their investments, and they want to think about investments that are fun to think about: stocks (or options or crypto) that are volatile, stocks of companies that do fun or interesting or world-changing things, stocks of companies with charismatic and entertaining chief executive officers, meme stocks.

There is not much in between. In particular, the whole industry of active mutual fund management is built on the idea that, if you don’t want to manage your investments, you can pay someone else to do it for you. But that idea feels passé in 2023. These days, if you don’t want to manage your investments, the accepted approach is to pay someone else almost nothing to almost not manage them for you: An index fund will do almost no managing and charge almost no fees, and that is widely considered the optimal approach. And if you want to manage your investments, you want to manage your investments; you want to pick fun stocks, not hire a star mutual fund manager to do the stock picking for you.[1]

Where does that leave the active mutual fund managers? Bloomberg’s Silla Brush and Loukia Gyftopoulou report that things are bad for them:
Across the $100 trillion asset-management industry, money managers have confronted a tectonic shift in investor appetite for cheaper, passive strategies over the past decade. Now they’re facing something even more dire: The unprecedented run of bull markets that buoyed their investments and masked life-threatening vulnerabilities may be a thing of the past.

About 90% of additional revenue taken in by money managers since 2006 is simply from rising markets, and not from any ability to attract new client money, according to Boston Consulting Group. Many senior executives and consultants now warn that it won’t take much to turn the industry's slow decline into a cliff-edge moment: One more bear market, and many of these firms will find themselves beyond repair. …

More than $600 billion of client cash has headed for the exits since 2018 from investment funds at T. Rowe, Franklin, Abrdn, Janus Henderson Group Plc and Invesco Ltd. That’s more than all the money overseen by Abrdn, one of the UK’s largest standalone asset managers. Take these five firms as a proxy for the vast middle of the industry, which, after hemorrhaging client cash for the past decade, is trying to justify itself in a world that’s no longer buying what it’s selling. …

“It’s a slow but surely declining trajectory,” said Markus Habbel, head of Bain & Co.’s global wealth- and asset-management practice. “There is a scenario for many of these players to survive for a few years while their assets and revenues decline until they die. This is the trend in the majority of the industry.”
Cheery! What do you do about this? One approach is to get into some adjacent business that does not rely on stock-picking; Abrdn “cut the business into three parts: a mutual fund business, a wealth unit that also serves retail investors and a platform for financial advisers — a strategy that has yet to prove it’s working.”

The other approach is for active managers to get out of liquid easily indexed public markets and into something else. Abrdn has also “largely abandoned competing in large-cap equity funds, choosing instead to emphasize small-cap and emerging-market strategies.” And of course there is private credit:
For many other firms, private markets — and, specifically, the private-credit craze — are now the latest perceived savior. Almost everyone, from small to giant stock-and-bond houses, is piling into the asset class, often for the first time. In the past year and a half, a surge in M&A in the space has been driven by such houses, including Franklin, that are eager to offer clients the increasingly popular strategies, which typically charge higher fees. Others have been poaching teams or announcing plans to enter the space.

“I think that’s a big driver for many of these firms — they look at their own financials and think about what’s going to keep us afloat over the next few years,” Amanda Nelson, principal at Casey Quirk asset-management consultancy at Deloitte, said in an interview.
“Just buy all the stocks” is a cheap and easy investing strategy that is also endorsed by academic research, but “just make private loans to all the buyouts” sort of obviously doesn’t work. So there is room for investment selection, and fees, there.

Meanwhile at the Wall Street Journal, Hannah Miao reports that actually retail stock-picking works great:
Wall Street has long derided amateur investors as unsophisticated market participants, prone to buying high and selling low. But the typical individual investor’s long-term mindset and penchant for risk-taking has proved fruitful in the technology-driven market of the past decade, defying the “dumb money” caricature.

The average individual-investor stock portfolio has risen about 150% since the beginning of 2014, according to investment research firm Vanda Research, which began tracking the data nine years ago. That beats the S&P 500’s roughly 140% during the same period.
Some of this is about stock selection: Recent years have been good for the stocks that retail investors tend to like.
The typical small investor holds an outsize position in megacap tech companies. Apple, Tesla and Nvidia alone make up about 40% of the average individual’s stock portfolio, according to Vanda. Although big tech stocks plunged last year, those investments have dominated the market for most of the past decade and have helped fuel the S&P 500’s 10% advance this year.
But some of it is apparently behavioral: Individual investors can be more contrarian than professionals can.
One advantage small investors have over professionals: They don’t have to worry about reporting performance to clients. That helps some individuals feel comfortable riding out market downturns. …

Everyday investors are known to buy the dip, piling into markets during weak periods. Many jumped into stocks in March 2020 when the market plunged at the onset of the Covid-19 pandemic, and rode the high as shares rebounded.
Crudely speaking, if index funds offer market performance, and retail investors on average outperform the market, then professional investors on average will underperform the market: “Over the past decade, about 86% of all large-cap U.S. equity funds have underperformed the S&P 500, according to S&P Dow Jones Indices.”

This seems bad for the big asset managers? They are squeezed from both sides: There is the rise of indexing, but there’s also the pretty good performance of individual investors who pick their own stocks. For a long time now, one argument for active management has been along the lines of “sure index funds look good in a rising market, but wait until the market goes down; then people will see the value of active stock selection.” But in fact people have seen the value of owning a lot of Apple and Tesla, which they can just do on their own. The real argument for active management surely has to be something like “sure index funds and also individual stock trading look good in a market dominated by the biggest names, but wait until Tesla and Apple underperform and the way to make money is by buying stocks that retail investors have never heard of.” Which is a harder pitch.

Comments

  • Good article. Easy conclusions. Nice sound to them, But reality is a bit different I suppose. I think the WSJ article which said retail investors do just fine, and better than professionals, is probably too anecdotal. Nothing about reality and what we hear from individual investors playing zero day options and triple leveraged ETFs ties in with this.
  • edited October 2023
    Thanks @Old_Joe and @Devo

    Oversimplified but interesting reading. I was surprised it doesn’t mention robo-advisors for the “set-it and forget-it” crowd. Also, the trend towards index funds which is highlighted is older than some of the participants on this site. A good friend of mine and investor was singing their praises back in the 90s. (I’d have more money today had I listened.) And @MJG’s affinity for index funds here led to many spirited debates at least a decade ago.

    Interesting that under that second set of investors (who trade a lot) no mention of ETFs. They would seem to be ideal for trading - but I’ve no idea the degree to which individual investors actually do so.
  • hank said:

    Interesting that under that second set of investors (who trade a lot) no mention of ETFs. They would seem to be ideal for trading - but I’ve no idea the degree to which individual investors actually do so.

    I was thinking the same thing regarding PRWCX and its new equity only ETF of the mutual fund, TCAF.

    If TCAF is easier to trade, how will it's trading dynamics impact PRWCX?

    You can't short a mutual fund. You can't buy options on a mutual fund. You can with an ETF.

    Will that be a good or a bad thing for the mutual fund that the EFT mirrors?


  • I was looking at the historical performance of a large-cap blend mutual fund yesterday (a good fund -- rated "Gold" and "five stars") and couldn't help but notice that 100% of its outperfomance over the past decade went straight to operating expenses. Strip those out and the fund matched the S&P 500. So every ounce of excess returns went not to the shareholders of the fund but to the fund company (over that particular time period at least). And that doesn't include the effect of taxes for those holding the fund in a taxable account. My acceptance of that sort of thing wanes as each year goes by.
  • https://www.bloomberg.com/opinion/articles/2023-10-23/nobody-wants-mutual-funds-now

    The page contains five pieces. Though four of them are unrelated to the title of the page. The actual title of the copied piece is: Barbell Strategy

    Omitted in the OP transcription are citations (links) to the text quoted within the piece:

    Silla Brush and Loukia Gyftopoulou report citation (paywalled):
    https://www.bloomberg.com/news/features/2023-10-22/active-vs-passive-investing-money-managers-confront-end-of-bull-market?srnd=premium&sref=1kJVNqnU

    WSJ citation (lnot paywalled): https://www.wsj.com/finance/stocks/who-you-calling-dumb-money-everyday-investors-do-just-fine-9dd63892?mod=hp_lead_pos8

    That WSJ article addresses @Devo's concern: I think the WSJ article which said retail investors do just fine, and better than professionals, is probably too anecdotal. Nothing about reality and what we hear from individual investors playing zero day options and triple leveraged ETFs ties in with this.
    Vanda calculates the average portfolio by analyzing individual investors’ brokerage-account trading activity in U.S.-listed single stocks. The firm’s analysis excludes purchases of exchange-traded funds and mutual funds, along with transactions made through retirement accounts or investment advisers.
    The WSJ piece has a graphic comparing individual investors' concentration in the biggest name stocks vs. S&P weights that goes beyond the quoted text's mention of Apple, Tesla, and Nvidia. Also overweighted by individual investors are Amazon, AMD, and Netflix. Underweighted are Microsoft, Alphabet, and Meta (all underweighted by about half).

    The WSJ has another graphic comparing individual investors and S&P 500 portfolios by sector. Aside from overweighting technology (as mentioned in the quoted text), consumer discretionary is heavily overweighted, constituting about a quarter of investors' portfolios. Also of note is the substantial underweighting of healthcare (less than 40% of the S&P 500 weight); see MFO thread on healthcare.

    Also omitted is footnote 1 (at the end of the 3rd paragraph):
    One important element here is that mutual funds were once a way to diversify your stock portfolio in a world where the normal way to buy individual stocks was in round lots of 100 shares. If you had $10,000 to invest, that might get you 100 shares of one or two stocks, whereas a mutual fund could buy dozens of stocks for you and give you fractional ownership of each of them. But now you can trade individual stocks for free and buy fractional shares directly from your broker, so that benefit of mutual funds is much less important.
    With 40% of portfolios invested (on average) in three stocks, that's not using cheap trades to diversify. That's doing what small investors have always done - buy a handful of stocks they recognize.

    Again from the WSJ piece:
    Robinhood users tend to “invest in what they know and use,” according to Stephanie Guild, head of investment strategy at Robinhood and a JPMorgan Chase veteran of about two decades. “That’s really no different than generations before...”
  • msf
    edited October 2023
    sfnative said:

    I was looking at the historical performance of a large-cap blend mutual fund yesterday (a good fund -- rated "Gold" and "five stars") and couldn't help but notice that 100% of its outperfomance over the past decade went straight to operating expenses. Strip those out and the fund matched the S&P 500. So every ounce of excess returns went not to the shareholders of the fund but to the fund company (over that particular time period at least).

    According to M* Investor screener, there are 14 share classes of large cap blend funds rated gold and 5 stars. Discarding the S&P 500 funds and the GMO funds (not generally accessible), that leaves only PRILX and PRCOX.

    You're likely looking at the former, since as of Sept 30th, its net returns (after expenses) exactly match the index M* uses. But it slightly underperformed VFIAX over the same period.

    However, the latter outperformed M*'s selected index by 0.57%/year over the decade ending Sept 30th; it outperformed VFIAX by 0.36% over the same time span, per Portfolio Visualizer. And the three year tax cost ratio of PRCOX is exactly ⅓ as much as that of PRILX.

    FWIW, PRILX had the best risk adjusted return (highest Sharpe ratio, highest Sortino ratio) of the three funds per Portfolio Visualizer.
  • Well, I thought that Matt Levine's piece might liven things up a bit around here, and it seems to have done just that. :)
  • Thanks for getting the ball rolling, OJ.
    As ever, I read stuff like this while asking myself how well I fit into any of those models of the average retail investor.
    My mutual fund managers are inevitably going to pick some stocks I would not personally touch: the Magnificent Seven. Tesla. The mega-banksters.... And absolutely no puts and calls and shorts for me. L-o-n-g only. I like to find good companies in uncrowded trades. So, less well-known names. Contrarian? I dunno. At the moment, I don't expect ANY help from the FED with my portfolio until at least 2025. Still 30%+ in junk. Bond fund share prices rise and fall, but never with the volatility of stocks. Meanwhile, back at the ranch, I get "paid" handsomely every month. And then there are the quarterly dividends from my equity-income fund: PRFDX. And the dividends every quarter which I insist upon from whatever stocks I buy.
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