November, 13, 2023 - read
“Mutually assured destruction is a doctrine of military strategy and national security policy which posits that a full-scale use of nuclear weapons by an attacker on a nuclear-armed defender with second-strike capabilities would cause the complete annihilation of both the attacker and the defender.1” This is clearly a hyperbolic metaphor for the mutual fund business model, where high fees may be charged without justification and out of habit. That is, if everyone is charging high fees for the same commodity, the market will respond appropriately with decreased demand.
The efflux of assets in the mutual fund industry is captured in the graph above. By no means do we claim that this is the end of the mutual fund industry; we leave that to deities, financial pundits, and economics Nobel laureates. What is of note is that there is a lack of green over the past two years. Charging higher fees is more facile if the performance is there and if it is not commoditized. The Industry Life Cyle chart (Industry Sales versus Time) leads us to believe that we have moved from the Introduction phase to the Growth phase, past the Maturity phase, and well into the Decline phase. This goes hand in hand with Product and Process innovation over time where Product Innovation decreases with Process Innovation peaking out and then declining with increasing deceleration2.
In the basest of interpretations, this reflects the move to ETFs, where the costs can be lower. This also may reflect the move to factor investing and to thematic investing insofar as innovation is concerned. Factor investing is embraced as the process innovation is increased because handling a subset of the S&P 500 doesn’t necessitate the hiring of 500 individual stock pickers; it might also be done with the “right” set of rules for a computer to systematically trade. Product innovation decreases in the sense that some of these thematic offerings could look like the old sector mutual funds, just designed in a slightly different way. Tech sector mutual funds can arguably be thought of as machine learning or artificial intelligence ETFs without too much of a leap. The elephant in the room is the dissolution of benchmark performance. Benchmark performance, which is usually the bane of mutual fund managers, becomes harder to nail down because the benchmark is so specialized now. The argument of active versus passive performance has become more and more subjective. Again, we are not attempting to forecast the end of the mutual fund industry, but it is informative to apply business strategy to the industry if for no other reason to identify the appropriate business cycle.Industries mature just as people grow older. What is important is to recognize why they might still be useful or why they may not. We believe ETFs are appropriate vehicles in which to trade based on their attributes.
1 Mutual assured destruction - Wikipedia
2 Contemporary Strategy Analysis by Robert M. Grant
Past performance is not indicative of future results. Remember, there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investment strategies discussed in this article) will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Please remember to always speak with your individual advisor before making any investment decisions.