The Death of Mutual Funds

Investors are speaking with their wallets, but their comments about actively managed funds aren't fit for publication.

In the first quarter of 2008, assets fell at all but one of the 25 largest U.S. mutual fund management groups. The only fund group that reported an increase was Pimco -- a fixed-income shop. This continues a recent trend where customers are abandoning actively managed mutual funds in favor of passive index funds, hedge funds, and low-maintenance target-date funds. T. Rowe Price Group has seen inflows of more than $1 billion per month in its target-date funds -- over half of the company's overall fund inflows.

Kevin Parker, president of Deutsche Bank's money management business, believes that actively managed funds' days are numbered. "Some day, maybe in my lifetime, the world will be split into passive investors and into alternatives," he told the Financial Times. "What's left in the middle is an endangered species."

That's a shame, because done well, mutual funds are the finest investment vehicle ever designed.

I said "done well"
It's no secret that most actively managed funds are awful. The industry is characterized by high fees and poor performance -- roughly three out of every four actively managed funds lose to the market over time, while charging investors a pretty penny for the privilege of subpar performance.

But believe it or not, there is a select group of actively managed funds capable of delivering long-term market-beating performance, while providing investors with broad diversification and peace of mind. A good actively managed fund will provide better returns than an index fund and more transparency than a risky hedge fund. Good funds are hard to find, but they're worth their weight in gold.

The best of both worlds
An index fund will buy you peace of mind -- and by definition, results that lag the benchmark index. A hedge fund will buy you exposure to a giant black box that could make you a lot of money ... or explode overnight. But a good mutual fund will give you exposure to the best of both worlds: market-beating returns and broad diversification.

Consider Motley Fool Champion Funds recommendation Third Avenue Value (TAVFX). Under the stewardship of investing legend Marty Whitman, this fund boasts a modest expense ratio, a winning long-term track record, and an experienced and highly disciplined manager.

Whitman is a dyed-in-the-wool value hound who isn't restricted by style box or geographic constraints. As of Jan. 31, he held positions in big boys like Microsoft (Nasdaq: MSFT  ) and Intel (Nasdaq: INTC  ) , foreign firms like POSCO (NYSE: PKX  ) and Toyota Motors (NYSE: TM  ) , mid caps like Alliance Data Systems (NYSE: ADS  ) , and smaller fare like Investment Technology Group (NYSE: ITG  ) and Datascope (Nasdaq: DSCP  ) .

The only common thread? These companies are cheap.

So far, this tactic has paid off in spades for Third Avenue Value shareholders: Whitman has crushed the S&P 500 over the trailing five- and 10-year periods. And Whitman expects this performance to continue.

"I am confident that the common stocks owned by Third Avenue are issues of companies which are well financed, well managed, and are selling at prices that represent huge discounts from private business values or take-over prices," he wrote in his most recent shareholder letter.

Don't know what you got 'til it's gone
I don't blame any investor for bailing out of a poorly run actively managed fund. But jumping into low-return index funds or risky hedge funds isn't the right answer.

Instead, investors should be seeking the cream of the actively managed crop: funds with experienced management, low expense ratios, and a time-tested investment strategy. Champion Funds boasts a broad collection of such names. To see a detailed write-up on each of our recommendations, click here to begin a free 30-day trial.

Rich Greifner does not own shares of any company mentioned in this article. Third Avenue Value is a Champion Funds recommendation. Microsoft and Intel are Inside Value selections. POSCO is an Income Investor pick. The Fool has a disclosure policy.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 30, 2012, at 4:21 PM, DVUUYTI wrote:

    Isn't it amazing how "smart" these journalists are that can do a little research and past post.

    Thanks for telling us what the answer "isn't" Rich, that sort of advice has never been a $ making directive...can you tell us what the right move "is"?

    No? wow, what a surprise. Now tell me again how your journalistic/investment expertise is any better than that of the typical mutual fund management team....

    oh, riiiiiiight.

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