8 replies to this topic

[JacobGalt]

In a world that no stock funds (i.e. funds that invest most of their assets in public companies) existed, the average return of stock investing would go up (due to management fees being eliminated) and the people who worked in those funds and received the management fees would be doing more productive work.

Why doesn't the world tend to this? Is it because everyone thinks their stock fund can beat the stock market?

[Steve D'Ippolito]

I think the average investor is outsourcing the research that really ought to be done. The fee can be worth it not to have to spend hours a day poring over reports etc.--and that assumes you even have the training to evaluate them when there's an incentive, often, for them to be obfuscative.

[aequalsa]

the average return of stock investing would go up (due to management fees being eliminated)

While true in a sense, someone might make the argument that the increased irrationality that the removal of professionals would cause would lead to worse returns. It would be a difficult and probably impossible thing to prove, but it could very likely be true.

[Reidy]

If a practice has become profitable and has established itself in the market, the presumption is that it delivers benefits to people. That doesn't mean that you're wrong if you disagree, but it does mean that the burden of proof is on you.

As #2 mentions, funds offer research and diversification that are beyond the small investor's reach. Anyone who wants to do his own research and make his own picks is free to do so; this has become much easier with the internet, and plenty of people do it.

To say that diversified funds tend to return what the overall market returns is almost a tautology. A more appropriate comparison would be between funds and solo or stock-club investors. I've never seen data on this. Once I read the advice that a good way to tell when a stock is about to fall is to watch odd-lot trades. These are purchases by non-professionals, who tend to get in late, just as the price is peaking.

This reminds me of the Marxist notion that we'd all be better off without investors and managers, because all the wealth would then go to the workers. If the alternative decision-making procedure (e.g. the government, or a vote of employees or consumers) made just the same decisions, then this becomes a tautology. But, as we all know, these methods don't make the right decisions. That's a point that #3 made.

Edited by Reidy, 14 April 2012 - 10:37 AM.

[JacobGalt]

To say that diversified funds tend to return what the overall market returns is almost a tautology. A more appropriate comparison would be between funds and solo or stock-club investors. I've never seen data on this. Once I read the advice that a good way to tell when a stock is about to fall is to watch odd-lot trades. These are purchases by non-professionals, who tend to get in late, just as the price is peaking.

They actually tend to return LESS than the market, due to fees and other costs. That's my main point.

[Reidy]

QED. Funds earn their money by providing a service that investors find valuable. That's my main point. The difference between market averages and fund returns is a measure of that value.

The relevant comparison is not to market averages but to what individual investors earn by doing their own research and making their own picks. That's one of my secondary points.

[Tyco]

Well, any serious investor ought to be sufficiently diversified, as it greatly reduces the risk of losing all your money/equity. So that means you need to keep tabs on 30+ companies, in order to avoid operational/custodial risk (ie. the fact that you could lose a lot of money because you weren't paying enough attention, for instance if you did not fill out a form to claim your cash dividend or whatever). If you invest into an equities fund, they do all that for you.

Also, say you have strong convictions about investing, but not granular enough to pick individual stocks. Like if you believe a certain industry sector is going to generally perform well. Instead of guessing what stocks are sensitive to this sector, you can just put your money in a fund whose managers share your convictions.


So the appeal of fund managers is not hard to see. This still leaves the unsettling statistic of funds under performing the market after fees. I suppose one answer might be that the 'market average' is skewed upwards by highly volatile stocks which have rocketed in price. Portfolio managers would tend to avoid these types of stock because generally they want to keep the risk/volatility of their portfolios low, to remove the chance of complete disaster. Maybe if you picked a bunch of stocks at random from within 1 or 2 standard deviations of the market median price, then compared their performance against the returns from equity funds, the funds would look better.

Another thing to consider is that if you removed all equity fund managers from the market, the market itself would change. Hedge funds etc. do a lot of research into the companies they invest in (or short), essentially acting as critics/judges on the quality of companies and their management. They then affect the price of those stocks through their buying and selling, ultimately ensuring that stocks in general are priced more and more accurately. If this wasn't the case, then solo investors would fall victim to overvalued prices more easily.

[Nicky]

In a world that no stock funds (i.e. funds that invest most of their assets in public companies) existed, the average return of stock investing would go up (due to management fees being eliminated) and the people who worked in those funds and received the management fees would be doing more productive work.

Why doesn't the world tend to this? Is it because everyone thinks their stock fund can beat the stock market?

Because your premise is wrong. In a world without stock fund managers, the uninformed small investors would be investing in all kinds of nonsense. The management fees would be eliminated along with any knowledge and effort put into what is and what isn't worth an investment.

[ex_banana-eater]

Because your premise is wrong. In a world without stock fund managers, the uninformed small investors would be investing in all kinds of nonsense. The management fees would be eliminated along with any knowledge and effort put into what is and what isn't worth an investment.

Uninformed investors would still have the opportunity to invest in index funds which outperform managed funds, and require no managers (I believe they do some type of computational rebalancing every so often).

But ideally uninformed investors would just be able to stay out of the stock market and keep their money in cash, which would be backed by gold, and increase in purchasing power every year. They're unfortunately forced into a stock market they don't understand by inflationary monetary policy, which provides a larger market for fund managers.

Edited by ex_banana-eater, 26 April 2012 - 08:29 PM.