Fifteen years in four colored lines.
The Thousand Words
The chart below illustrates the change in asset size of four prominent mutual funds over the past 15 years. I've removed the funds' names, replacing them with a short description, such as Star Stock Manager or Index Stock Fund, because the point of this column is not the rise and fall of individual funds, but instead the varying fortunes of fund types. The point: Today's fund investors think very differently than did those of the 1990s.
At the beginning of our tale, in 1998, Star Stock Manager Fund reigned supreme, boasting more assets than the other three funds combined. The mutual fund industry had almost disappeared by the mid-70s, shredded by the 1973-74 stock bear market and plummeting bond prices. The industry was resuscitated first by growth in money market funds, late in the 1970s, then by government-bond funds in the mid-80s. Its third and largest boom, however, was the U.S. stock fund, typically run by adventuresome solo managers.
Fidelity was the largest, most visible, and most successful of such managers, running not only the single biggest mutual fund, but also the biggest fund complex. Fidelity managers were famously permitted a great deal of slack in interpreting their funds' prospectuses. (When Jeff Vinik ran Fidelity Contrafund FCNTX, for example, he favored expensive, glamorous biotechnology stocks, which he regarded as "contrarian" because while those stocks were very pricey, he believed that they should have been pricier still. That was the first and last time that I heard contrarian defined in such a fashion.) Concentrated funds that held relatively few stocks were also popular. If active management was good, then highly active management surely must be better.
Or not. While Fidelity's stock funds had beaten their benchmarks through the early 90s, with consistency that seems barely believable today, they began to totter in the mid-90s. Concentrated funds, too, disappointed. By 2001, Star Stock Manager Fund was suffering the highest redemptions in the industry and was helping to put the entire breed of actively run, single-manager U.S. stock funds under siege. Since 2001, such funds in aggregate have collectively faced redemptions, each and every year.
Star Stock Manager Fund was surpassed in assets in late 2003 by Star Bond Manager Fund, and then shortly thereafter by Group Active Stock Management Fund, which became the world's largest mutual fund for the next four years, until dethroned by the 2008 stock crash. Unlike its predecessor, Group Active Stock Management Fund was cautiously run, with investment responsibilities spread over several portfolio managers. It was the careful investor's active fund. Due to the fund's group structure as well as its blue-chip focus, its returns weren't likely to stray far from those of its benchmark.
The fund neither failed in its execution nor succeeded. Unlike Star Stock Manager Fund, which posted poor returns during the 2000s, Group Active Stock Management Fund kept pace with the S&P 500. Some years it was a little better, some years a little worse. Thus, its group approach delivered as promised by preventing the sort of pratfall suffered by Star Stock Manager Fund. But the fund did not make a strong positive case, either, which left it stranded when the stock tide turned against it. Investors bailed, making it--as with Star Stock Manager Fund before it--temporarily the industry's most-redeemed fund.
In 2009 Star Bond Manager Fund surged back into the lead. Twelve months later, it had become the largest fund ever, blowing past the $250 billion mark. Post 2008, bond funds were very much in favor. Curiously, bond-fund buyers seemed not to have noticed active stock managers' struggles. So even as they shunned active stock funds, they preferred active bond funds. That made a certain amount of sense, as Star Bond Manager Fund had a long history of outperformance. But then again, so had Star Stock Manager Fund and Group Stock Active Management, and how had those funds played out?
Sure enough, after a couple of strong years, Star Bond Manager Fund began to go the way of its predecessors. Relative performance slipped, bad publicity rose, and the inevitable redemptions began. By early 2013, Star Bond Manager Fund had moved into the lead for redemptions, where it remains to this day. (You're probably not having much trouble putting the face to this name.) As with Growth Stock Active Management before it, the fund found itself under fire for management at the time that its asset class fell out of favor. Unpopularity was inevitable.
Today's largest fund, Index Stock Fund, represents a trend long in the making. Index funds have gained market share steadily for 25 years now. The chart below shows the percentage of assets in all open-end funds (that is, mutual funds and exchange-traded funds) that is invested passively. As the shape of the line demonstrates, passive funds have picked up market share at the same steady rate for a quarter century now.
Indeed, had I wished to tell a more complicated tale--a sin of which I am often guilty, but not today--I could have plotted both Index Stock Fund I and Index Stock Fund 2. The former fund also had its moment as the largest mutual fund, but it has been supplanted in recent years by its sibling, which mimics a broader benchmark. Indexing, too, has evolved since the 1990s, although in its case the change involves improving on a popular fund, rather than exiting funds that have disappointed.
The upshot? The fund industry is becoming ever-more institutional in its structure. Manager risk has declined due to the movement from the star sole manager to group management to, increasingly, indexed assets. Costs have declined. Fifteen years ago, most new fund purchases were of funds that had expense ratios of greater than 1% per year. Now such funds capture few new monies. Fifteen years ago, the fund industry liked to think of itself as a boutique supplier. Today, investors realize, it mostly sells commodities.
As for those four funds? You've probably guessed them by now, but here they are for confirmation.
John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.