InvestmentNews, NY
12-17-07
Brokers unload on fund study findings
Load fund investors clearly do worse, researchers say
Brokers and other industry observers are steaming over a new study that shows
that investors who buy load funds do far worse than the funds themselves.
The study found that from 1991 through 2004, load fund investors
underperformed by 1.82% per year, while no-load investors underperformed by
just 0.47%.
The research findings, released this month, looked at actual returns investors got
on a fund-by-fund basis, based on cash flows in and out of funds, versus a buyand-hold return.
The study was funded by the Zero Alpha Group, a Washington-based group of
fee-based advisers that advocates passive strategies.
The study was conducted by professors Geoff Friesen of the College of Business
at the University of Nebraska-Lincoln and Travis Sapp of the College of
Business at Iowa State University in Ames.
Some industry observers questioned the study's objectivity, since the Zero Alpha
Group promotes independent advisers who use index funds.
"It seems extremely self-serving," said Joel Blumenschein, president of Freedom
Investors Corp., a broker-dealer based in Hartland, Wis.
"As academic researchers, neither of us has an ulterior motive," Mr. Friesen said
in response. "The data are very robust."
The study was built off of prior research that was published in September, Mr.
Friesen said. That earlier work was the first research to find differences between
load and no-load funds.
The study, which questioned the value investors get from traditional distribution
channels and implied that brokers are giving poor advice, rankled many in the
industry.
"To make a blanket statement that all [registered representatives] are bad, you
can't do that," Mr. Blumenschein said.
'SOMETHING'S GOING ON'
Mr. Friesen said the study didn't make that conclusion. "But something is going
on there [because] load fund investors seem to be doing much more poorly."
"I really get sick of reading that crap" about fees and no-loads being better for
investors, said Robert Hanten, president of Solidarity Financial Inc. of Wayzata,
Minn.
The study seems as if the authors "were receiving coaching from fee-based
advisors with an agenda," said one rep at an independent firm who asked not to
be identified.
Negative "market timing" effects have been shown before, but this study was the
first to show differences between different classes of load, no-load and index
funds.
Critics claimed that the re-searchers compared load funds with no-loads and
simply measured the effects of sales charges.
But that's not the case, Mr. Friesen said, noting that the study controlled for the
effects of sales charges by comparing results at the individual fund level.
Even then, the results "are at best, ambiguous," said John Robinson, managing
director at Hawaii Wealth Management in Honolulu.
Mr. Robinson and other critics pointed out that the study couldn't explain why
investors in "legal no-loads," which have a small 12(b)-1 fee, did worse than
investors in class A and C shares.
The poor showing of legal no-loads "is perplexing," said Mercer Bullard, founder
and president of Fund Democracy Inc. of Oxford, Miss., a mutual fund
shareholder advocacy group.
A lot of the legal no-load assets are at Charles Schwab & Co. Inc. of San
Francisco, said Mr. Bullard, one of the study's authors.
"There is no obvious reason why [investors in a fund supermarket] would be
more inclined to attempt market timing," the study said.
The researchers did not distinguish between no-load funds managed by advisers
or purchased directly by investors.
"I wouldn't be surprised if brokers [using no-load funds] are doing better than selfdirected investors" using the same products, Mr. Bullard said.
Many defined contribution plans use funds from the big, pure no-load companies,
and their incoming cash flows are based on dollar-cost averaging, said Avi
Nachmany, director of research at Strategic Insight Inc., a New York consulting
firm. As a result, those funds don't experience performance-chasing, he said.
The dollar cost averaging effect is a "key issue in the data" the study used, Mr.
Nachmany said.
Performance lags across all share classes could also be ex-plained by the fact
that mutual funds experienced increasing cash flows while the stock market rose
over the time period measured, Mr. Robinson said.
The Securities Industry and Financial Markets Association of New York and
Washington declined to comment about the findings.
Mr. Bullard said the results will have to be duplicated by other researchers before
they're widely accepted in academia. He expects the study to be published early
next year.
While the study did not attempt to explain why the data showed that load fund
investors or their brokers made poor timing decisions, observers didn't hesitate to
speculate about a number of reasons.
One may be that "advisers are putting investors in the wrong class of shares,"
said Louis Harvey, president of Dalbar Inc., a Boston-based financial services
market research firm. "It's not the fund itself, it's the class," he said.
Dalbar has studied the mistiming in mutual funds since 1984.
"It's possible that brokers who sell load shares, especially B shares, might be
seduced by the allure of market timing," and that in order to keep the client, they
go along with clients' illusions that they can beat the market, Mr. Bullard said.
"It could be that some [brokers are] really bad [and are] creating a large enough
negative timing that it's showing up in the averages," Mr. Friesen said.
Other research has suggested that some performance differentials might be
caused by a few active traders, such as hedge funds that market-timed some
load fund groups, Mr. Robinson said.
Some reps "will take advantage of people's greed," Solidarity Financial's Mr.
Hanten said.
He said that in 1999, "I [was] begging people to leave the market, but other other
reps [were willing to] take every dime ... and put it in the market."
Dan Jamieson can be reached at djamieson@crain.com.