November 25, 2006: Do mutual funds stink?

So says Laszo Birinyi in the new issue of Forbes magazine. And Mr. Birinyi presents a good case for his premise.

He states that the financial press generally presents a poor picture of hedge funds. .."accidents waiting to happen". Yet, Birinyi accurately states that the financial world's best minds are gravitating towards hedge funds. Why? Better compensation for achieving positive results. Beyond that, these managers enjoy a freedom to maneuver that is often prohibited at traditional money management firms. One recent academic study found that mutual fund managers who also ran hedge funds had better results than those who did not. Hedge fund managers are at the cutting edge the business and receptive to new ideas. I think all investors in mutual funds should size up their managers. Are they 26 years old trying to manage three or more mutual funds and hundreds of millions of dollars for a "big box" mutual fund company?
Have they been banished to your fund because of poor performance elsewhere? Does this remind one of our Catholic clergy being shifted about to minimize scandal a decade or more ago?

Birinyi states that "if you regard hedge fund managers as reckless gunslingers, you are missing and important part of their culture. While they certainly seek to outdo the market, they also put strong emphasis on not losing clients' money."

Mutual funds' typical customer is not a sophisticated client. Fund companies preach long term investing. Yet long term investing for many, if not most mutual funds means allowing a fund manager to have a quick trigger finger for the popular investments of the day - a bad idea-, generating a steady stream of buy and hold assets from uninformed customers, thus generating a steady stream of assets and fees. Year in, year out. The majority of funds lag behind the S&P 500. Some are way, way behind. At a time when the S&P is showing double digit gains, large cap growth funds are barely in the black. According to fund tracker Lipper, they had a total return of 0.2% for the year through September 30th. This category of funds controls 20% of all mutual fund assets.

And what does one get for the fees paid to mutual fund managers? Herd investing according to Birinyi. And he has data to prove it.

What Laszlo Birinyi recommends for the individual investor is to buy individual stocks on your own. Be your own hedge fund manager. Through research and readings, the individual investor should do better than most mutual funds. I also recommend using ETFs as an important component of going it alone, something Birinyi does not address.

I have "gone it alone" for almost thirty years. I have had some disappointment, but no long term regrets. I agree with Birinyi.By in large, mutual funds stink.