Common Sense on Mutual Funds

This part turns from the investment focus of the first three parts of the book to an examination of why so many mutual funds have failed to measure up to the implicit expectations of investors. The problems are grounded in the nature and structure of today’s mutual fund industry. We have moved this industry away from our guiding principles to new principles that ill-serve fund investors. No longer is the prudent, disciplined stewardship of fund portfolios the core function around which all others are satellite. Rather, the distribution of shares through aggressive advertising and selling techniques has become the industry’s core function, dictating both the way we manage funds and the kind of funds we offer, as well as the prices at which we offer them. Management has been replaced by marketing as the talisman. Technology, despite the incredible blessings it has brought to the information available to fund investors and to the enhancement of the services we provide, has become our bane. Technology, in fact, has facilitated the metamorphosis of mutual funds from their role as the providers of sensible long-term investment programs to proxies for individual common stocks, to be actively traded by short-term investors in marketplaces resembling casinos.

With the affairs of mutual funds controlled by external management companies, considerable tension exists between the interests of fund shareholders and fund managers, a separation of ownership from control that has been counterproductive for shareholders. Yet, most fund directors seem oblivious to these issues, and fund boards, seemingly uncritically, routinely rubber-stamp contracts with underperforming managers and acquiesce in a steady round of management fee increases. A new structure under which funds would manage themselves may be called for. In the final chapter of Part IV, I explore the implications of new governance structures that would better serve the interests of shareholders. Such commonsense structural changes, I argue, could once again make prudent investment management ascendant over aggressive marketing as the focus of the industry, with great benefit to fund investors.