Earlier this month, the Financial Post published an article entitled, "Five Things You Should Know Before Buying a Mutual Fund." The article made some good points about mutual funds and how their performance is based, quite naturally, on what is good for the fund manager and others associated with selling the fund. The customer's interest, unfortunately, comes in dead last.
In this article, we'll examine professional investing and its biases, including the most damaging of all to an investor's pocketbook, a lack of attention to the larger business cycle. More on that below.
First, let's take a look at this informative Financial Post story. Here's the introduction:
Mutual fund managers are highly incentivized to gamble if their fund performance is bad, says Peter Hodson, since most of their compensation is in the form of bonuses.
The mutual fund business is a great industry — for the people that sell them. For investors, it's not so good.
No one, of course, ever talks about the bad side, as it is just too profitable for those employed by the investment industry money machine …
The article goes on to mention the five things an investor should know in advance of placing his money with a mutual fund.
1. Fees: It is almost impossible to beat market averages regularly after deducting fees from performance. "Paying 2.5% in annual management fees when expected returns are just 5% or 6% is ridiculous, especially these days," the article tells us.
2. Short-term focus: Mutual fund prospectuses tell us about fund strategies but it is not uncommon for funds to depart radically from those strategies if performance is down. Investors may believe, therefore, that they are receiving a certain style of investing when they are not.
3. Bonuses encourage gambling: A bias toward risk is built in to fund management, as the better a fund does, the larger the bonus. Managers will make big bets during the year to increase performance because bonuses are paid annually. Long-term strategies suffer as a result and short-term results often suffer as well.
4. Asset gathering overrules fundamentals: Investors may not be receiving the truth about market fundamentals from a fund manager because the emphasis is on gathering assets and thus information is skewed toward the positive. "A manager's goal is to keep investors calm and get more money in the door."
5. Excessive deal buying and stock trading: Managers that run actively traded funds are liable to get more attention from the industry and get more "deal flow" as well. This strategy also leads to more commissions. "The end result? – plenty of deal buying, trading and associated fund costs."
We can see from this that investing in a mutual fund is basically investing in someone else's business model. You are not an "investor" within this context so much as a profit center – someone else's profit.
Unfortunately, these kinds of practices are not just restricted to funds. Wall Street itself operates the same way – focusing on the short term and putting clients' interests behind their own. The only way to protect yourself is to be educated about what goes on … and why.
The biggest issue regarding financial education has to do with the business cycle itself. Internalize the reality of the business cycle and you will suddenly gain a whole new perspective on how professional investing works – and more importantly why it often doesn't work.
The article warns there are more problems with mutual funds than those mentioned, and the big one I can think of is that there is no incentive for fund managers to explain the larger business cycle – nor even to take it into account.
According to modern free-market economic theory, business cycles are created by central banking policy. Central banks print money but bankers never know how much is enough. Thus, almost always too much is printed and economies roar to life and then spin out of control. The result, eventually, is a bust – and it is inevitably one that mutual funds are caught up in.
The average mutual fund manager will NEVER extricate himself from a market prior to a crash. First, the mandate of a fund is to stay invested, hopefully within the parameters of its strategy. Second, the fund manager himself may not recognize the warning signs of either a bubble or imminent collapse.
Fund managers are generally trained as mainstream (socialist-oriented) Keynesians. They simply do not take into account the amount of government interference with the marketplace. They may even believe it is "natural" and thus discount its distortive effects.
And even though they are professional investors they probably do not understand or even accept the idea that money flows are critical to stock market performance. Instead, they concentrate on performance, not realizing the performance is puffed up by overprinting of currency that has inflated the results of both Main Street and Wall Street.
The idea of concentrating on the "bottom line," when that bottom line is subject to the manipulation of money flows, is a grand illusion that has developed through persistent propaganda provided to us by the mainstream media that has a stake in promoting this inaccurate perception.
Thanks to this perspective, people simply do not understand even the basics of what makes sound money and inspires real economic growth – and that goes for Wall Street as well as Main Street. You need to step away from "mainstream" thinking when it comes to investing. Streamline your sources of knowledge and recognize that money manipulation often trumps analysts' expectations.
I subscribe to several longstanding newsletters and research reports written by independent people whom I trust to do the work for me; for a few hundred dollars a year I have more than I need for objective analysis that enables me to select the best stocks, specifically chosen for the current stage of the business cycle.
Please remember that the game is rigged against you unless you are in control. Naturally, no one else cares as much about you and your family's well being as you.
It is a fool's game to blindly entrust your financial future to others for whom your success is not their first priority, rather than hiring information sources and viewing them as components of an overall team you assemble to assist you as the captain to make your own decisions.
At the end of the day, this is the game that has been played in the world's stock markets for decades now. The amount of money being redistributed from the working class, the average person, is staggering. The process enriches those closest to the spigot of control, the central banks and those who exercise the greatest influence on Wall Street.
Today I focus almost entirely on helping to introduce quality companies to my institutional network for investment capital within the context of business-cycle analysis. This is critical. Not to recognize the realities of modern investing is to perform a kind of professional dereliction of duty.
Let me say this clearly: Neither you nor I designed the world's financial system and all we can do is figure out how not to be part of aiding and abetting any investment activity that is reprehensibly immoral, however you define morality.
There was a time when I was a tad bit naïve and actually believed the financial system was fair and that professional asset managers were working in a fiduciary capacity to put their unit holders interests above all else. But that's simply not so, and the more you understand about the way the world REALLY works, the better you will be able to protect your portfolio, your wealth and your loved ones.