Holy Grail

Fidelity Has Found the Holy Grail: Oh Wait, False Alarm!

Holy Grail

One of the toughest (but also the most rewarding) aspects of being in the financial services industry is garnering and protecting clients’ trust. The tough part of the equation comes mainly from being grouped amongst all financial professionals, who for the most part are working incredibly hard to do right by their clients, but there are always those who are not and have to ruin the reputation of the vast majority. Couple this with an investment strategy that calls on ignoring the market, settling for “average,” and controlling emotions during turbulent times and you have one heck of a challenge.

Trust is the bedrock of our business, but trust is often abused and the wolf in sheep’s clothing emerges to be nothing more than pure self-serving. A recent article on ThinkAdvisor.com highlighted a research report put out by Fidelity Investments that specifically addressed a new way to find the “right” active funds. This research was done by Fidelity Investments, which as a company wears multiple hats of investment advice including brokerage services, insurance services, and of course fund management, and stated that investors could find the cream of the crop of US Large Equity Funds by sorting based on fund assets under management (AUM) and fees. Specifically, funds that are relatively large in terms of assets under management, but also are the cheapest amongst their peers have outperformed their stated index by approximately 0.18% per year over the last 13 years.

Sounds great, right? Something so simple as AUM and expense ratio ended up being the answer to the most sought out question in the history of financial markets: mainly, how do you beat the market?

Now, you may already suspect from our tone that we took this research with more than a grain of salt and didn’t just abandon our mission to change the way the world invests. This, amongst many other daily "dimes," is really nothing more than a marketing campaign. But let’s at least start with giving merit where merit is due.

Costs are very important. We believe anybody who has been investing for a reasonable amount of time knows that the more you pay your manager, Uncle Sam, brokerage houses, etc. etc., the less you will take home for yourself. The finding that some of the cheapest and active funds ended up outperforming their expensive colleagues overtime is not that difficult to understand.

When it comes to large assets under management, on the other hand, it doesn’t make mathematical sense. For every dollar that is put into the game of active management expecting to win, there must be another dollar that is going to lose. This is not us pulling a rabbit out of a hat here, it is mathematical certainty. The more and more money that is shoveled to any one active manager to try and outperform the market, the more and more money other active managers will have to lose, all else equal. Although many fund companies may hype that they have the best and brightest, it wouldn’t take too long on any fund companies’ website to find out the amazing credentials that most head portfolio managers have. Who should we believe?

Although Fidelity has stated a figure of 0.18% per year, they give no indication of variability, which IFA has always discussed when we are talking about fund performance. That 0.18% is not certain, so there must be a probability assigned to it. As we mentioned in a recent article on fund performance, statistical significance must always be in the discussion. We have examined the fund offerings of large active managers like Fidelity and American Funds before and have found nothing compelling to back up their conclusions of superior performance (you can find articles here and here). The 0.18% mentioned in the analysis could be, and is expected to be, nothing more than pure randomness.

It is also worth mentioning, that Fidelity’s research seems to support choosing their funds when choosing an active fund given that they are one of the largest mutual fund families in the business and are also more on the modest side when it comes to fees. Which hat is really being worn right now by Fidelity?

The pursuit to find the Holy Grail of fund performance will never end. Claims like expense ratio AUM = success will be part of our industry until the end of time. It is the job of an advisor to sort through all of the claims and find the best and most reasonable solution out there for their clients and keeping their trust.

Challenge accepted.