The past 12 years have been a difficult time for equity investors. The so-called lost decade has seen major stock market averages like the Standard & Poor’s 500 struggle to regain the highs seen in 2000 and briefly in 2007. To add insult to injury, investors during this period were hit with all manner of volatility, including a global financial crisis, flash crashes and bungled high-profile initial public offerings.
Three big trends show how investors are trying to get more bang for their buck and are unwilling to rely on the Wall Street firms, many of which helped bring the global economy to its knees just a few short years ago, for their investment needs.
For many, investing once meant opening an account with your local stock broker in order to purchase a portfolio of individual stocks and actively managed mutual funds.
Today, that model has been turned upside down. Financial advisers are leaving the brokerage firms to become registered investment advisers. This “breakaway broker” trend is a fundamental change in the relationship between adviser and client.
Registered investment advisers, or RIAs, are held to a “fiduciary standard” requiring advisers to act in the best interest of their client, a higher standard than required today for broker-dealers.
The other big difference is the way RIAs are paid. Instead of relying on commissions, RIAs are typically paid based on assets under management. While this arrangement is not perfect, it more closely aligns the interests of client and adviser.
If investors are changing who helps manage their money, it makes sense that the way money is being managed is also changing. Passive investing, or indexing, long popular with big institutional investors, has caught on with individual investors. In booming markets like those seen in the 1980s and 1990s, superstar managers like Peter Lynch of Fidelity Magellan fame made picking stocks seem easy. The problem is that active management is on average a loser for investors.
Research by Standard & Poor’s shows that, over any reasonable time horizon, like five years, active equity and bond funds lag their respective benchmarks. Higher fees and incremental trading help drag down the performance of active managers. Investors have caught onto this fact and have made the Vanguard Group, the originator of the retail index fund, into the largest mutual fund manager in the United States.
Another big trend, the rise of exchange-traded funds, is a direct result of this embrace of index investing. The breadth, depth and low cost of most ETFs now allow individual investors to invest like institutional investors did not all that long ago. Since the introduction of the first ETF, the SPDR S&P 500 fund, in 1993, ETFs have accumulated more than $1.1 trillion in assets under management in this country.
While that still lags assets in open-end mutual funds, all the trends are pointing toward the rise of ETFs as the investment vehicle of choice. Despite the fact that ETFs over time have put downward pressure on fees, every U.S. major mutual fund manager is looking to enter the ETF marketplace in some form or fashion. Many analysts believe ETFs represent a better model for collective investment that will continue to disrupt the existing open-end mutual fund business model.
Every major study of fund performance shows one variable to be a significant determinant of portfolio performance: fees. The higher the fee paid, either upfront or an ongoing basis, the worse the performance. In a very real sense, gross portfolio performance is uncertain, but fees are not.
The bottom line is that the trend toward RIAs, index funds and ETFs represents a desire on the part of investors to keep more of what they make.
There are capable financial advisers, active managers and open-end funds. None of which are going away anytime soon. If nothing else, the last decade should teach us that financial market returns are guaranteed to no one.
Therefore, keeping costs low in every sense of the word has become of utmost importance to investors. Nor should the next decade be any different.
New online investment managers—fueled by venture capital, powerful algorithms and the power of the Internet—are looking to compete with incumbent advisers. While this threat seems like a distant one at present, investment advisers should take note of the fact that nearly every industry touched by online competition has been transformed in the process.
Investors, on the other hand, should cheer because it makes implementing the lessons from the lost decade even easier.•
Viskanta, of Zionsville, is founder and editor of the Abnormal Returns blog, and author of the recently published book “Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosphere.” Views expressed here are the writer’s.