are what we think.
Survey on fund management:
Also see article on private equity here.
Jul 3rd 2003
From The Economist print edition
A little-noticed guilty party in the stockmarket's boom and bust
AFTER the bubble, the blame. Over the past two years, investors, regulators and prosecutors have competed to hurl mud and lawsuits at anybody they could plausibly hold responsible for causing such big losses to so many. Bosses have been blamed for cooking the books and inflating their pay; auditors faulted for being too cosy with their charges and even helping in the cooking; investment bankers singled out for dodgy research and touting dubious stocks. But one set of actors in the tragedy has so far escaped largely unscathed: the fund managers who look after investors' money.
As our survey in this issue argues, however, fund managers were far from blameless. Indeed, they were right at the heart of the bubble. Throughout the 1990s, they were urging investors to pile into equities, often of the riskiest variety. They reaped enormous profits from their clients' gullibility, since their pay depended largely on the market value of the assets they had under management. Their fees and charges were typically buried in the small print. And they were just as guilty as Wall Street banks of misleading investors: tales of heroic past performance and of safe double-digit returns reinforced the foolish notion that markets would rise forever.
The truth is that, for the most part, fund managers have offered extremely poor value for money. Their records of outperformance are almost always followed by stretches of underperformance. Over long periods of time, hardly any fund managers have beaten the market averages. They encourage investors, rather than spread their risks wisely or seek the best match for their future liabilities, to put their money into the most modish assets going, often just when they become overvalued—whether tech stocks and dotcoms in the late 1990s or, now, corporate bonds, hedge funds and private-equity funds (see article). And all the while they charge their clients big fees for the privilege of losing their money.
Even so, lawsuits against fund managers are unlikely to fly. Two New York judges have just dismissed suits against various investment banks over equity research (see article): proving wrongdoing by a fund manager will be harder still. The regulation of fund managers should be tightened up: notably, by standardising tables of past performance and insisting they be accompanied by health warnings in large print, and by requiring fund managers to disclose all fees and charges, including transaction costs, upfront. But broadly, investors should accept more blame themselves for their losses: they were starry-eyed about likely returns and ignored signs of overvaluation.
There are, however, two more specific lessons that investors should learn from their experience with fund managers. One is the merits of indexed investing. Whether you are a retail investor in a mutual fund, or a pension-fund trustee, you will almost never find a fund manager who can repeatedly beat the market. It is better to invest in an indexed fund that promises a market return but with significantly lower fees.
The second lesson is the need to balance risks and returns more carefully. A pension fund, with predictable long-term liabilities, should not normally be invested only in high-risk equities, for example. A retired couple in search of a steady income should not put their nest egg into a fund that invests only in volatile tech stocks or high-risk emerging markets. In the long run, high returns are available only in exchange for taking high risks. Investors should remember that truth, and allocate their savings accordingly.
Copyright © 2003 The Economist Newspaper and The Economist Group. All rights reserved.