The Wrong Side of History

It's Not the Numbers, Stupid!
Yesterday's column showed the cultural resemblances between the mutual fund industry's sales leader, Vanguard, and its sales laggard, American Funds. The two organizations are similarly conservative, releasing mainstream, risk-averse funds that behave predictably. Both families operate strategically, with among the longest time horizons in the business. Neither Vanguard nor American Funds will rush a fund to marketplace so as to capitalize on a hot asset class or on a currently popular investment trend. Finally, American Funds, too, runs funds at a relatively low cost, albeit nowhere near at Vanguard levels.

What the column didn't reveal were the performance results. In the table below are the average annualized gains for the U.S. stock funds offered by American Funds, compared with the results for Vanguard Total Stock Market Index (oldest share classes only). 

The funds in the first column have collectively suffered $110 billion in net redemptions over the trailing three years. The fund in the second column enjoyed $45 billion in net inflows. The funds in the first column are on average less volatile than the fund in the second column. That makes sense ... how?

International-stock funds are a similar story, with American Funds having heavy outflows despite having strong five-, 10-, and 15-year numbers. The firm has not done as well with its bond funds, but that is immaterial as almost all the outflows have been from its stock funds.

There is a logic to the matter; it's just not to be found in performance. American Funds, as I stated yesterday, is lined up on the wrong side of history. It was on the right side of history two decades ago. At that time, most big load-fund companies were brokerage firms that emphasized bond funds and launches of hot new funds. With its steady, ongoing message of equity exposure and its independence from being attached to a distribution company, American Funds were perfectly positioned to ride the stock bull market of the '90s. 

It hasn't been perfectly positioned for the past decade, though. The company didn't believe that it needed to create a retail brand. It did. The company didn't believe that it needed to woo the media. It did. The company did make an effort to diversify from stock funds and to crack the 401(k) marketplace, but it was not a strong effort--and it has paid the price recently, with stock funds in general struggling to attract assets since 2008 and much of the new inflows into mutual funds coming via 401(k) plans. 

In addition, 2008 happened. American Funds historically had fared well during bear markets because of its funds' high cash positions and preference for blue-chip firms. As a result, part of the company's marketing pitch was its funds' ability to dodge the worst of bear markets. However, 2008 took down nearly all equity funds, including those at American Funds. The funds disappointed those who, perhaps unreasonably, expected more. 

In summary, American Funds is struggling because of distribution and marketing decisions, not because of performance. This is relevant because American Funds is often held up as an example of the failure of active fund management. But that is not so, and to interpret American Funds' business difficulties as a comment on the issue of active versus passive management is to misread the data. More on that tomorrow. 

Big Hat, Small Cattle
Morningstar's Gregg Wolper sent me an article from Ignites, an industry trade publication (subscription required), titled "Hancock Cuts Fees, Funds to Boost Brand." The savings? For every dollar past the first $3 billion in assets, John Hancock is lowering the management fee for its Global Absolute Return Strategies fund to 1.15% from 1.20%.

Color me underwhelmed. Yes, lower is better than not being lower, but lowering a high fee by 5 basis points once the first $36 million has been collected* isn't exactly a big move. 

* Slightly more than $36 million, actually, as the fund's current management fee begins at 1.30%, then scales down to 1.20% as asset increase. 

Union Cards
Dow Jones has an article out titled "Fallout of M.B.A. Crisis," covering the near collapse of The Thunderbird School of Global Management. Thunderbird has endured a 75% drop in its applications over the past 15 years and has been forced to sell real estate so as to service its debt. Although Thunderbird's situation is particularly dire, it is part of a larger trend, as 62% of business schools reported having fewer applicants in 2012 than in 2011.

Makes sense to me. I've never quite understood the degree's appeal to employers. The decision-making classes in an M.B.A. program are terrific. Understanding how to make decisions based on data is about as useful a skill as exists. But those classes are very general; in a sense, they are continued liberal arts coursework rather than specific business training. Otherwise, the M.B.A. curriculum tends to teach things that can be picked up on the job, such as derivatives and options markets or marketing strategy. It's not clear to me how much an employer should value that.

I suspect, though, that the very top M.B.A. programs will continue to thrive. Regardless of what students learn from those programs, they are likely to be bright, ambitious, focused, and hard working when they graduate. Employers will happily pay for those attributes. 

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.