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Are Fund Investors Better Off Than Before?

Jason Stipp
Russel Kinnel

Jason Stipp: I'm Jason Stipp for Morningstar.

Are fund investors are getting a better deal than before? We're checking in today with longtime Morningstar FundInvestor editor Russ Kinnel on that question.

Russ will be sitting on a panel later this month, Sept. 19th. It's FundInvestor's 20th anniversary. He will be sharing some tips there, but we're going to get a preview from him today.

Thanks for joining me, Russ.

Russ Kinnel: Good to be here.

Stipp: A lot has changed in the fund industry; some things have stayed the same. I want to talk about whether fund investors are getting a better deal or a better experience out in the market today.

We've had, obviously, some issues in the last 10 years with market conditions, but as a fund investor, some things could be better for you.

Let's start with one of the, perhaps, most important ones: expense ratios--what you pay to invest in a mutual fund. Are fund investors getting a better deal today than they were 20 years ago or 10 years ago?

Kinnel: The answer is definitely yes. Expense ratios for the average open-end fund have come down significantly. The typical fund investor is paying just 77 basis points. So, they really have come down, and that's not even accounting for ETFs.

You bring ETFs into the picture, and it's even better right. The ETFs have really brought fees down. Not all of ETFs are cheap, but there are a lot of cheap ones. So, there are more cheap funds than probably ever before.

Stipp: I think investors often wrestle with the idea of getting what you pay for, which is something they experience in other parts of the marketplace.

But we've done a lot of studies on fees, and of course if you're getting active management, you want to make sure that active manager is doing well. But buying or paying extra for a mutual fund, especially an actively managed fund or any fund, doesn't always get you that outperformance, right?

Kinnel: That's right. Expenses are a strong predictor of fund performance. They're not the only thing you need to look at, but they are an important part of that.

I think one of the reasons people get confused is, some of the funds with low costs are actually in dollar terms taking in a lot of money, because maybe they're running $50 million, or in the case of PIMCO Total Return, $100 billion-plus. But people miss that and think about the expense ratio. But really in dollar terms, often the best managers are well paid. But yes, investors can get really good managers for low cost.

Stipp: And especially with something like an index fund, where it's essentially a commodity type of investment product, there is no reason that you should pay any more than the lowest price you can get, potentially?

Kinnel: That's right. And ETFs have really dialed up that competition. We've seen both on the open-end and the ETF side, firms have lowered their expenses in response to competition. So, definitely when you're looking for an index fund, cast a wide net and see how cheap you can find it.

Stipp: You mentioned ETFs there, Russ, and I think one thing ETFs have done is opened up certain areas of the market, for individual investors especially, that were difficult for them to invest in before.

So, my second question is about investors' choice, their selection in investment vehicles. How has that changed, and is more choice always a better thing for investors?

Kinnel: I think ETFs are great example that, on the one hand, they are a great place for a sober long-term investor. On the other hand, there are a great way for you to blow all your money really quickly, because you have some very obscure areas that ETFs mine. You can trade all day in them. So, you kind of have a casino on one end and a stately old bank on the other end attached to an ETF. So, there are some ways to get in trouble, or there are some ways to really invest wisely for your retirement.

Stipp: And some of those ETFs, and I know some of the newer alternatives, are using a lot more exotic instruments. To what extent is it difficult for investors to even understand these, and how can they get in trouble that way potentially?

Kinnel: I think it's true that you have to be a little skeptical about anything that's exotic or complicated, because that doesn't necessarily mean "better." It does mean higher fee, which again raises the bar and makes it harder for you to succeed.

So you really have to be careful, find a manager with an established track record, and a strategy you can understand. You don't have to understand all the intricacies, but you should have realistic expectations of the ups and downs of a fund, and if you can't do that, stay with something that's more plain-vanilla.

Stipp: What about the trend of fund companies putting out funds that are of the time--hot funds and hot asset classes. This is a trend we've been following for a while, and it can lead investors to put their money into something that's already reached or is close to reaching its peak.

Is this trend still continuing in the fund industry, or are fund companies getting a little bit more responsible about not putting gimmicky funds out there just to capture the next latest thing?

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Kinnel: There are still a lot of gimmicky funds out there, and you really want to be wary. It's very much a "ripped from the headlines" approach. Now, many of the major fund companies don't do it, but there is always someone, particularly now in the ETF space, willing to come out with a nanotech or an obscure country or a leveraged [fund]. There are a lot of really high-risk [vehicles], and they're generally put out in a fairly cynical way that will get attention, people will run after it, but you wouldn't see the managers put their own money into these funds.

So, there are still plenty of ways that you can lose your money.

Stipp: And fund companies will say our investors are demanding this and we're giving it to them, but it isn't always the best thing. What investors want isn't always what's best for them.

Last question for you, Russ: Some of the trends in expenses, some of the trends in having more rational fund lineups, would you say that the fund industry as a whole is getting healthier as far as the metrics that we watch? Are we headed to better times, but maybe we're just not all the way there yet?

Kinnel: I would say generally healthier, but I think there is also still some disturbing investor trends. We see a lot of money chasing headlines. So, for instance, if we see negative news about the U.S. economy or positive news about emerging markets, we might invest that way, but that really ignores a lot of the important fundamentals.

So I think there is still some investor behavior that needs to be improved. I think the fund industry still has some ways to improve, but certainly the industry as a whole is healthier than at the end of, say, '08, and the average investor is wealthier than at the end of '08.

Stipp: Do you think that fund companies have a role in helping investors invest better, have better investor behavior and not chase certain asset classes? Is that their job in addition to providing the investment products?

Kinnel: Yes. They are fiduciaries. It's their job to make sure that investors have a good result. It's also the job of financial planners and advisers. We at Morningstar, obviously, want to do our best to help people have a good experience. So, it's a lot of different people coming together, but fund companies are a crucial element.

Stipp: Lots of changes in the fund industry, Russ, and it's good to have you on board to keep track of those for us. Thanks for joining me today.

Kinnel: You're welcome.

Stipp: Russ will be on a panel, again, Sept. 19th to celebrate Morningstar FundInvestor's 20th Anniversary. Please tune in for that.

I'm Jason Stipp. Thanks for watching.