Tuesday, 6 February 2007

Mutual Funds vs ETFs

Many people have commented on the much higher Management Expense Ratios as being the worst disadvantage of mutual funds compared to ETFs. While high MERs are decidedly detrimental, to my mind the real killer is the other oft-noted fact that most mutual funds give poorer returns than the related market benchmark. So much for the touted "professional management" advantage supposedly provided by mutual funds. Simply by choosing an ETF, which mimics some benchmark or other, one can do better than most mutual funds (e.g. this paper or this extensive review on US funds).

On top of that, there are now more equity mutual funds than there are equities, so choosing the best one(s) requires more filtering of information than would the direct route of investing in equities. When choosing to invest savings in a mutual fund, one is in effect having to replace the assessment of a company with the evaluation of the people making the investment decisions, the mutual fund managers. By managers, I mean the people inside the fund management companies. They are ultimately the ones who make the purchase and sale decisions. Unfortunately, there is even less transparency and available information about fund managers than about companies, who are obliged to report results regularly. Like every other human endeavour, be it hockey, brain surgery or auto mechanics, some people are superb at it, some are abysmal and most are somewhere in between. How can one tell the "Warren Buffett" from the "bottom of the class"? Pick any fund website and about the only info on the people is the name and how many years of industry experience and degrees the manager has. There's nothing about that person's past performance or results. Maybe if they did publish such information it would be worth reconsidering. In the meantime, I have very little invested in mutual funds.

1 comment:

Anonymous said...

I agree with your synopsis. It is extremely difficult to pick winners in the mutual fund industry, since so few have a long term record of market outperformance. And when they do, it's hard to know how much longer they'll be staying on the job or if they'll be leaving the company and going to another or starting their own.

Still, if you can focus on managers which have 10+ years of beating the market consistently and with lower volatility, and they are running their own company then I think it makes sense to at least consider placing a portion of your money into their fund(s). True quality is hard to come by, but when you find it it's often worth paying for.

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