I Know Why Mutual Funds Fail to Perform | Business Markets and Stocks News

“Why, sometimes I’ve believed as many as six impossible things before breakfast.”

You’ve heard this a hundred times, I’m sure: Most actively managed mutual funds fail to beat the S&P 500. [i]

The general assertion is that fund managers lack the skill necessary to outperform the benchmark — some formulation of “YOU SUCK AT YOUR JOB.” Which is a reasonable assumption, except that it makes very little sense that mutual fund companies would en masse turn their portfolios over to people who show so little aptitude.

Most people commenting on mutual fund performance haven’t actually ever run a fund. But I, after having launched and managed three funds with Motley Fool Funds, have the unique opportunity to look through both lenses. No, good Fool, the problem isn’t the portfolio managers — not all of them, anyway. The things that actually cause mutual fund underperformance are far more pernicious than mere incompetence.

In brief, there are four main factors —¬†customers, consultants, regulators, and structure —¬†that force mutual fund managers into conventional thinking, when the key to extraordinary market returns is unconventionality. It’s a basic disconnect, and it is really hard to resist.

New York City’s Financial District. Image source: Getty Images.

The basic problem, distilled

At the core of mutual fund management is an agency conflict. Fund shareholders benefit, obviously, when the value of their shares goes up. Fund managers, on the other hand, make more money by growing assets under management, providing a powerful…

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