Shrinking Slices, More Options, And Saying No

Fifty-seven thousand, five hundred and twelve. That’s the number of global funds launched between January 2005 and 2013. Just to be clear, that is not the number of funds in existence over that period, it’s the number of brand new funds. This mind blowing number comes from an excellent new Morningstar study, The Rise and Fall of New Funds: Why some funds succeed and others don’t.

How is it possible that the market can support so many new funds? Here’s how: “Ah, this thing I purchased three months ago isn’t working, let’s try this instead.” Unfortunately, too many people behave as if the grass is greener on the other side of the field. This nugget from their study is really eye-popping, emphasis mine:

Globally, we find that new funds account for the preponderance of new asset flows. In 2015, global fund flows reached approximately $516.4 billion across the three asset classes in our study- -equity, fixed income, and allocation. Of the total, new funds with less than 12 months of track record accounted for $379 billion, or 73% of all flows.

It’s no wonder why active management, from hedge funds to mutual funds, are having such a hard time.  The size of the alpha pie never changes, but with more than 57,000 new entrants in just over an eight year period, the slices keep getting smaller. Below is a visual I created to show this.

the pie

With better technology, easier access to information, lower expenses, and more options than ever, it has never been a better time for the retail investor. However, because of the overwhelming options available today, paradoxically it’s becoming harder, not easier for investors to achieve average results. Here is Morningstar again, emphasis mine:

Second, the good news for investors is that their preferences have generally paid off in better outcomes. Funds that exhibit the types of traits listed above are generally the better cohorts of funds from the investor’s perspective. The main exception to this comes from investor preference for style tilts, which is directly contrary to their best interests. If portfolios have been disclosed, the investing populace tends to place a premium on funds that buy popular, large-cap, overvalued, and liquid stocks that have done well recently. Investors appear to ask themselves, “Have I heard of these stocks?” and respond with additional flows to the new fund when the answer is “yes.” Unfortunately, in almost all instances, we would expect the opposite choice to result in a higher expected return. This is the most disappointing finding of the paper, though perhaps not entirely surprising as discussed in earlier sections.

One of the most underappreciated aspects of a financial advisor is their ability to say no. As potential distractions hit an all-time high with each passing day, a growing responsibility of the advisor is to keep their clients focused. Unfortunately, far too many “advisors” are more than happy to feed off an investor’s susceptibility to change their mind. This is from their study, emphasis mine:

Thus far, we have used the shorthand “investors prefer” or “investor preferences” to discuss fund characteristics that result in higher flows. But this is perhaps misleading. The simple fact is that the majority of money in the global investing marketplace is heavily intermediated. The majority of flows are not due to the actions of the retail investor but are directed by the result of some complex interaction between an advisor, an institution, and a platform. The intersection of these three parties can result in varying levels of choice for different types of investment products. Therefore, it is perhaps best to conjure an image of the web of intermediaries who compete for platform placement and attention from advisors. When we say “investors prefer,” therefore, it is perhaps more accurate to say these are the types of newly launched funds that most successfully navigated the network of distribution channels and most appealed to advisors. 

To conclude:

  1. The pie is the same size, but the slices are shrinking.
  2. More options makes average results harder, not easier.
  3. Successful financial advisors say no to distractions.

Source:

The Rise And Fall Of New Funds

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