A new research highlights the self-serving nature of the fund industry. One of the biggest problems with this industry is that the interests of the fund manager and the end investor are fundamentally misaligned. Further evidence of this mismatch between the interests of investors, managers and fund management companies is provided below:
- Struggling managers tend to take more risk
The two researchers found strong evidence that “there is a high degree of employment risk for managers as dismissal is often preceded by prior poor performance.” Certainly “relatively poor performance is followed by relatively high risk taking largely as a gamble to ‘catch up’ with one’s peers”. Fund managers can’t be blamed for wanting to keep their jobs.
- Houses give preferential treatment to high-fee funds
From a commercial point of view, fund houses prefer to have more money invested in high-value funds, which presumably explains why there is evidence that “fund management companies give preferential treatment to high-value funds in the family in terms of allocating hot IPOs”. Such IPOs typically attract higher inflows.
- Fund houses transfer risk from high-performing to low-performing funds
Ultimately, fund houses also want to increase their assets under management, and they know that “investor inflows respond strongly to past good fund performance but are relatively insensitive to past poor performance”. They are, in effect, incentivised “to transfer risk from high-performing to poor-performing funds. If the risky bets pay off, then inflows are greater than any outflows if the risky bets fail.”
- Fund houses incentivise customers to stay in the same fund family
When investors do desert poor-performing funds, fund houses obviously want clients to switch to another of their funds. Consequently they “now typically offer low cost switching options for investors to stay in the same family” but this is not in the client interest. To quote the study, “evidence shows that the majority of investors only hold mutual funds in one family. As fund returns within a family exhibit relatively high correlation, investors are less than optimally diversified.”To conclude, only when fund houses and individual managers genuinely put the interests of their clients ahead of their own will active funds be worth considering for the majority of investors. In the real world we live in, that may never happen.
Please read the full article here filled with more evidences.
And the research here.