Swensen on the Dangers of Mutual Funds

Yale endowment manager David Swensen has produced exceptional long-term returns over the long haul. And in a recent op-ed for The New York Times, he takes aim at some of those who haven’t been able to do that: mutual funds.

“Too often, investors believe that mutual funds provide a safe haven, placing a misguided trust in brokers, advisers and fund managers,” Swensen writes. “In fact, the industry has a history of delivering inferior results to investors, and its regulators do not provide effective oversight. The companies that manage for-profit mutual funds face a fundamental conflict between producing profits for their owners and generating superior returns for their investors. In general, these companies spend lavishly on marketing campaigns, gather copious amounts of assets — and invest poorly. For decades, investors suffered below-market returns even as mutual fund management company owners enjoyed market-beating results. Profits trumped the duty to serve investors.”

Swensen says mutual funds create volatile portfolio offerings. As these portfolios run hot and cold — which will happen to just about any portfolio — the fund companies rely on investors to chase hot funds and dump funds that run cold. Investors end up buying high and selling low, piling into funds with good recent performance that then end up lagging. Investors suffer, but fund companies make a bundle on fees, he contends.

What to do? “First,” Swensen says, “individual investors should take control of their financial destinies, educate themselves, avoid sales pitches and invest in a well-diversified portfolio of low-cost index funds, like those offered by Vanguard, which operates on a not-for-profit basis. … Such a strategy reduces the fees paid to the parasitic mutual fund industry, leaving more money in the hands of the investing public.”

Swensen also says regulators must do more to protect individual investors from mutual funds. He says, for example, that regulators need to encourage investors to embrace low-cost index funds rather than the “broker-driven churning of high-cost, actively managed funds”. He also says the S.E.C. should consider requiring companies to provide an index fund alternative to each of its mutual funds, and that the company explain and prove why the mutual fund is worth the additional fees.