In 1940, Fred Schwed wrote Where Are the Customers' Yachts?, a brilliant (and hilarious) assessment of Wall Street's ability to take care of themselves at the expense of their customers. One book reviewer summed it up perfectly: "The investor's need to believe somebody is matched by the financial advisor's need to make a nice living. If one of them has to be disappointed, it's bound to be the former."
Seventy years later, the book is as relevant as ever. In a new paper, Princeton economist Burton Malkiel shows us how.
"In 1970, there were 358 equity mutual funds," Malkiel writes. "Of the original group, 92 funds have survived."
How'd they do against the S&P 500 (SNPINDEX:^GSPC) benchmark? I've recreated Malkiel's findings, which compares the funds' annual returns to the index:
Of the 358 equity funds in 1970, 36 (10%) survived and outperformed the S&P 500 through 2012. That's probably close to what you'd expect to happen by random chance.
What about the rest of the funds? Malkiel writes:
We can be confident that the 266 funds that did not survive had poorer records than did the surviving funds! Funds with especially poor records in a mutual fund complex are often merged into other funds with better past records.
This might be unfair to individual fund managers. Forty-three years is a long enough period that each fund likely cycled through several, maybe even dozens, of managers. Peter Lynch, for example, was an excellent fund manager, but his performance won't show up in this chart because his fund -- Fidelity's Magellan -- was subsequently run by other, less talented managers.
But the fact remains: The huge majority of professionally managed funds will bow down to a brainless index fund over time. And it's only getting worse. So few professional funds existed in 1970 that most could, in theory, outperform the market. Today the industry is so large that it's a mathematical impossibility -- most funds can't beat the market because they effectively are the market.
But what really shocked me about Malkiel's data is that dozens of funds have underperform their benchmark for 43 years, and they are still in business.
Who is investing in these funds? Many people, with lots of money, I'm afraid. Where are the customers' yachts, indeed.