Facing challenges on all fronts, Wall Street banks are pinning some of their hopes on a relatively simple business opportunity: creating mutual funds for ordinary savers. Over the past few years, an expanding line of mutual funds created by the likes of Goldman Sachs and JPMorgan Chase has been drawing billions of dollars from investors looking to earn a good return on their retirement money.
For the banks, the fees that the funds generate have been among the few consistent bright spots of growth in a time of retrenchment on Wall Street. There is, though, one big problem with all the growth: History has not shown these banks to be particularly good at managing mutual funds, and their clients have paid the cost.
Most of the funds run by each of the four largest banks in the business — Goldman Sachs, Morgan Stanley, JPMorgan Chase and Wells Fargo — have underperformed their basic benchmarks over the past ten years, according to analysis of industry data done for The New York Times by Morningstar. And that does not include the funds that went out of business because of poor performance.
While some of the banks have seen better performance over more recent periods — in which the stock markets have been steadily rising — the investment products created by Wall Street’s biggest name, Goldman, have been particularly disappointing, with only 12 per cent of the bank’s mutual funds outperforming their relative benchmarks over the past 10 years, and 35 per cent over the last five years.
“It’s a good business for them — but that doesn’t mean it is a good investment,” said Larry Swedroe, director of research at Buckingham Asset Management.
There is a wide body of research showing how hard it is for actively managed mutual funds — like the ones run by the banks — to outperform low-cost funds like the ones that invest in a benchmarked index of stocks and bonds.
The banks have suggested in marketing materials that their investing prowess differentiates their offerings from the pack. But the relatively high fees banks charge for their mutual funds subtract from the ultimate returns and make it harder to compete against their most successful competitor in recent years, the giant fund manager Vanguard, a company that prides itself on offering low-cost funds.
Thanks in large part to its low fees, 80 per cent of Vanguard’s actively managed funds survived and outperformed a majority of peers during the past ten years. At Goldman, only 24 per cent did so and only 30 per cent of Wells Fargo funds did.
A Morningstar analyst for Goldman funds, Laura Lallos, said, “We do not consider their overall long-term performance to be a success anyway you look at it.”
The underwhelming performance of most funds is rarely mentioned when the banks discuss the big business opportunity they are going after in the asset management sector. When Goldman’s chief financial officer, Harvey M. Schwartz, spoke about Goldman’s “strategic initiative to grow asset management”, he said the “team’s done a great job”.
Troubled history
For Goldman’s bottom-line, the business has indeed been doing well. During 2014, the company’s funds drew $73 billion (Dh268 billion) of new money from investors, increasing revenues in the investment management division 11 per cent over the previous year. Goldman has nearly doubled the number of mutual funds it has offered over the last decade.
When Goldman and other banks discuss the performance of their funds, they tend to use statistics that are weighted by how much money is in each of the funds at the time of measurement. On this basis, Goldman says that 75 per cent of its clients’ money is in mutual funds that have been in the top half of competitors over the last five years.
A spokesman for Goldman, David Wells said that “there are many ways to determine the performance of mutual funds, but we choose to consistently focus on figures that we believe most accurately reflect the investment performance that our clients’ experience.”
The approach used by the banks, though, is not favoured by researchers because it skews the figures to where money is now, even if the money just entered top-performing funds and did not experience recent gains. Studies have shown that investors tend to put money into investments after periods of outperformance and then miss that outperformance.
Goldman Sachs and Morgan Stanley have acknowledged that their funds, broadly, have not been stellar in the past, but both companies have recently made big efforts to reshape their teams and improve the returns. That has helped increase the number of funds at both companies that have beaten their benchmarks over the past three and five years, though the outperformance slipped again during the last year.
Even when they do underperform, the funds pay off for the banks because investors pay the fees no matter what the returns are. An investor, for example, who put $10,000 into Goldman’s mutual fund for medium-size companies would pay around $1,143 in fees over five years, including a $500 upfront fee. That is about ten times what it would have cost if the money had been in a comparable fund at Vanguard, even though the Goldman fund would have led to returns that were six per cent lower than the Vanguard fund over the past five years.
Wall Street has a long and troubled history of moving into, and out of, the mutual fund business. In the 1990s, many of the big banks built up large families of mutual fund families that they marketed to clients of their brokerage divisions.
In the decade that followed, though, several banks faced investigations and fines for encouraging their brokers to sell the bank’s proprietary investment products even when they underperformed funds provided by outside companies. This was one of the factors that led Citigroup and Merrill Lynch, which is now a part of Bank of America, to sell off their mutual fund operations in 2005 and 2006.
Today, the banks that kept their mutual fund businesses continue to offer those funds through their in-house brokers and advisers. All the banks have said they do not rely heavily on selling their funds to in-house clients, but none of them provide data on how common it is.
The banks have occasionally acknowledged the difficulty that their mutual funds have in outperforming lower-cost alternatives that passively invest in an index of stocks or bonds. A report distributed by Morgan Stanley to its financial advisers last year said that “aggregate long-term performance and fees both favour passive over active” management.
The Morgan Stanley report said investors can benefit from actively managed mutual funds by carefully choosing funds that focus on areas where it is easier for active managers to outperform, like international and small company stocks.
The difficulty, according to advocates of passive investment management like Swedroe, is that once an area is viewed as fertile ground for active management, the competition heats up and the chances of outperformance go down.
“As the competition gets tougher,” Swedroe said, “it gets harder and harder to generate great performance.”
