2.1 The $13T Lie

big liarChapter Overview

Most mutual funds won’t beat a low-cost index fund over time

Morning Star

Based in Chicago, Morningstar, Inc. is a provider of independent investment research in North America, Europe, Australia, and Asia. There’s a UK site for Morning Star. One of the research products they have is rating mutual funds.

Five star rating

Morning Star’s five-star-rating system takes a bit of investigating as they also have an Analyst rating system (gold, silver, bronze).

This document explains that the Analyst rating system is a forward-looking assessment of a fund and the star system is an assessment of past performance.

So, a fund with the best past performance and a bright future would have a gold shield and 5-star rating.

Being speculative about future performance, the Analyst rating is just that – speculative. The star rating, however, is purely quantitative – but past performance doesn’t always tally with future potential.

Morning Star offers a lot of tools for UK investors – many of them free. This page is a good place to start.

$13T AUM

AUM is short for Assets Under Management, sometimes called funds under management (FUM). It is a measure of the total market value of all the financial assets within a specific fund or collection of funds. It’s a crude measure of popularity and fund size – but fund size and its performance may not correlate at all.

The book quotes that US mutual funds collectively boast $13T AUM, which, given that the recommendation for most people to avoid mutual funds and invest in low-cost index funds, implies that a lot of money is being invested in a sub-optimal way.

This industry survey at the end of 2013 suggests that there was £5T (approx $8T) AUM in mutual funds in the UK. On the face of it, perhaps the UK has smarter investors?

However with a UK population roughly 20% of the US population, maybe a more comparable UK AUM would be $ invested per person.

On that basis, a UK investor is 3X more likely invested in a mutual fund than their US counterpart. A crude metric, admittedly, but maybe the UK has even greater need of the advice contained in this book?

Hedge fund

In the US, hedge funds – unlike mutual funds – are unregulated because they’re geared towards sophisticated investors. They typically require a very large initial minimum investment and the money is locked in the fund for at least one year. Hedge funds are similar to mutual funds – but for the super-rich.

Clearly, I don’t need to worry about knowing too much more ..

Fund manager

Pretty-self explanatory – but I researched it just in case. A fund manager can be an individual or a group of people who manage a (hedge or mutual) fund.

All-weather portfolio
Here’s a quick video about how Ray Dalio and Bridgewater Associates invented the All-weather portfolio – also available as a pdf document.

Basically, it’s an investment strategy designed, on the whole, to perform well in all financial environments – all weathers.

While investing with Bridgewater isn’t available to mere mortals like me, the principles they use to construct a robust and diversified portfolio are detailed later in the book.  The UK Morning Star web site also has some tools which might come in handy later ..