Readers' Friday

Just Say No
July kicked off with a warmly received salute to contrarianism.

In a handwritten letter, Vizzini responds: "Should the popularity of your column concern the true contrarian? If you write that contrarianism is good, and readers agree, does that mean that contrarians are no longer contrarian? Wait. You knew that the readers would respond that way, so it was contrarian of you to put them in the position where they would seem to confound your beliefs. So contrarianism does work! Very clever of you. But what you didn't realize is that we knew that you were thinking that we didn't know what we did know." He continues in that vein for several hundred more words before the letter ends midsentence, amid smudged ink.

Vizzini, I would worry greatly about the success of contrarian strategies if I had 11 million subscribers, as these folks do. I'll be sure to let you know when I get there.

Tom Baker chimes in*: "Do nothing as long as it's the right sort of nothing." Wise observation, Tom. It is true that contrarians can struggle to distinguish between the different flavors of nothing. For example, holding subprime mortgages in the face of bad publicity through 2008 was the doing the wrong sort of nothing.

*The Doctor's quote comes courtesy of Philip Gribowsky.

The ETF Invasion
My modestly skeptical take on Schwab's hope to revolutionize the 401(k) marketplace drew this rejoinder from jrtaff: "Expense ratio[s] can make a massive difference. While the lowest cost index open ended mutual funds can be indeed cheaper than a nearly identical ETF, that is not what most 401(k)s use. Mutual funds have share classes of varying expense ratios whereas ETFs only have one. Not all 401(k) slates use the cheapest share classes, if they switched to ETFs, there would only be one option."

Good point. Exchange-traded funds do have the virtue of possessing only a single share class (at least for now). Also, I understated the cost advantage of Schwab's fund lineup. Yes, 401(k) providers can and do collect revenue from other places besides fund expense ratios, so those expenses are not the final word on a 401(k) plan's costs. That said, Schwab's ETF platform is very cheap compared with the standard offering for midsize to small companies. The Schwab ETF platform is a good thing. I don't believe that Schwab's innovation is the only positive happening in the 401(k) marketplace, not by a long shot. But its platform is certainly a part of the progress.

Love 'Em or Leave 'Em
This week's series on American Funds versus Vanguard surfaced several American Funds' supporters. Rathgar writes: "American Funds has been through net redemptions before as in 1998 and 1999 when they were considered too conservative. At that time many of the more aggressive fund families picked up assets (Putnam, Janus, Munder Net Net). How did that work out? The "in" investment these days is ETFs and index funds. These investments have their merits but I wouldn't be surprised to see American Funds not change a thing and do very well in the next 10 years--in terms of performance."

I wouldn't be surprised, either. In fact, I expect it. That said, the current switch from American Funds is more sensible than was the technology-stock chasing of the late '90s. Admittedly, some of the ETFs purchased these days are exotic and liable to be misused, and some of the departed American Funds' monies have no doubt gone into expensive bonds, but largely the monies are flowing into broad, low-cost stock indexes. Unlike those who bought into Janus and Munder in the late '90s, today's index-fund buyers will probably not regret their decisions.

tdejong asks, "One question, though: Will what has worked in the past for AF work in the future?" The same question was posed by Morningstar's Kunal Kapoor, who covered American Funds a dozen years ago. Kunal believes that American Funds was too slow to close its doors to new assets and that therefore the company's largest funds are too unwieldy. tdejong continues, "Due in part to size, even with large outflows, by the end of Jun 2012 the correlation [of Growth Fund of America] with Russell 1000 Growth was up to 98% ... many consider it simply an expensive large cap growth index fund."

Along the same lines, palmreader writes, "I'm guessing that the assets managed by American Funds have increased substantially over the past quarter century. I'm of the (unsubstantiated, except anecdotally) opinion that it's harder to actively manage large sums of money as compared to smaller amounts. Right or wrong, that concern might keep me from betting on AF's ability to repeat its outperformance over the next 25 years. That is, if their general unavailability to self-directed investors didn't preclude them from my consideration already.”

Finally, ThePrune casts doubt not on American Funds, but instead on the value of an off-the-cuff analysis like mine: "Rather than hash out the arguments here, I'd recommend the interested reader take a look at REALLY thorough studies published in 2010 by Fama & French (Luck versus Skill in the Cross Section of Mutual Fund Returns) or by Barras, Scaillet & Wermers (False Discoveries in Mutual Fund Performance: Measuring Luck in Alphas). Both studies incorporate all the domestic stock American Funds offerings as well as those from other fund companies. The effects of skill, luck, and expenses are clearly separated out. The studies are independent but come to amazingly similar conclusions."

Both the too-big-to-succeed argument and the academic studies deserve a longer discussion. Another day.

Tasteless
In "Lies, Damned Lies, and Taste Tests," I mocked Purity Vodka's taste-test challenge to Grey Goose, calling it a "trick" and a "con." A few days later, a package arrived, courtesy of Purity Vodka. Its "Founder and Master Blender" (now there's a job title), Thomas Kuuttanen, assured me that the company was not doing statistical chicanery, and that in fact his most excellent vodka did indeed taste better than that of Grey Goose. Enclosed were samples of each, for proof.

I admire your spirit, Mr. Kuuttanen. But not your spirits; I'm not much for vodka. This, on the other hand, I could happily drink. 

Speaking of which: I once tried Chateau Montrose, and it tasted like Robitussin. I don't think anybody can tell the difference between the two. Do you hear me, Monsieur Glumineau? Nobody can tell the difference. (Shipping address: 22 West Washington St., Chicago IL 60602.)

Where's That Chart?
Some readers have had trouble seeing my column's charts. If that happens to you, please drop me a line at john.rekenthaler@morningstar.com and tell me what browser version you are using. This normally doesn't occur with Morningstar's publishing system, so we're trying to gather clues to solve the mystery. Thanks.

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.