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This morning on National Public Radio, the Market Watch Report spoke of the huge outflows year to date in domestic equity mutual funds. The analyst posited that people had gone through too many bad markets and lacked confidence in the market and economy now. She said she believed a permanent reduction in allocation to equities had taken place.

Our view of this is quite simple. First, people have been systematically led to believe that investing in stocks for the long run is safe and effective.  The truth is that research shows a lower allocation to stocks (and to bonds!) than the traditional portfolios typically make is simply a better way to go. You can increase your returns and decrease your risk by adding other types of assets to the mix. This fact is not welcome in traditional investment houses, but is born out in many places- We recommend either Dr. Craig Israelsen’s 7Twelve or Mebane Faber’s The Ivy Portfolio as a great place to start to educate yourself.

Second and just as important, there are thousands of mutual funds and the majority of them are not managing your risk. They are concerned about benchmarks, style boxes, all sorts of things about which you could care less. What you care about is your money!!! You entrusted it to professional managers in order to make it grow through the miracle of compounding. You value return on capital, but also need return of capital. The majority of domestic equity mutual funds are not set up to protect your investment in bad markets. If you were told this when making an investment, you would probably not hire the manager. Would you go to a doctor who promised to take good care of you when you are well but who would rather not treat you when you are sick? That is essentially what you are getting from many fund managers. Good results when the market is healthy and poor results when the market is ill. Not enough-so, outflows make a lot of sense to us unless you find funds that put your interests first.

This week we received two charts that are so very instructive about the industry we are part of. Here is the first:

The source for this chart is Bloomberg. The story with it was the traditional sell side story, basically that the market is soaring but that it is not too late to join in. Appealing and compelling! Get on that train today!

The other chart we received was also from Bloomberg, covering the S&P 500 index going back to January of 2007 instead of February of 2009. 

So, the part from February of 2009 looked identical but the left side had a very large fall included. The point of that chart was to show that, from January of 2007 through  the late 2009 you still needed more rise in the market just to break even. Not compelling! Not appealing!!

Which chart is more important to an investor-the one showing that they need to hurry and join in the meteoric rise or the one that shows that they still have significant market losses and no compounding of your money? You be the judge.

Morningstar has released new information that over half of mutual fund managers have no money in their own funds. No skin in the game. There is no reason that over half the managers of mutual funds have no investment in their funds except-they are not good investments! I believe we could eliminate a lot more than half of the funds that exist without harming anyone except financial services companies. One of the reasons they are not good investments is Morningstar itself. The style boxes they pioneered (e.g. small cap value funds are one of the 9 equity boxes)are good for Morningstar. They get to rate thousands of funds as a result of their complicity in “filling the style boxes.”  It is also good for financial services companies, who got to roll out scores of funds to fit each of the style boxes. On the other hand, investors have a more simple need- managers who compound their money. A few good managers who are unconstrained, given a mandate to make money and mitigate risk are what investors need. Thousands of style box funds, mostly managed by people with no skin in the game and no mandate to manages investor’s risk instead of their own,……..well,…………what you see is what you get. And, in this case, it ain’t pretty.