How Mutual Fund Managers are Like Cigarette Makers

(from Jennifer Saranow Schultz's article on the New York Times' Bucks Blog, 8/18/2010 - click here to link to the original post)

Last week, my colleague Tara Siegel Bernard wrote about a recent Morningstar study that found that expenses were the most dependable predictor of fund performance and actually helped investors make better decisions than Morningstar’s star-rating system. Then, on Tuesday, Carl Richards wrote about how the study’s results stacked up with his own findings that the fund with the lowest expenses tended to win.

So, we apologize for coming back to this study one more time, but we couldn’t resist noting the nastiness of the rhetoric in a recent e-mail in which the founders of MarketRiders, an online service that helps investors build E.T.F. portfolios, compared actively managed mutual fund managers to tobacco companies.

They also compare Russel Kinnel, director of mutual fund research at Morningstar and the person who explained the study’s results on Morningstar’s Web site, to whistle-blowing tobacco industry insiders. We’ve excerpted some of the choicer parts of the e-mail, which went out to a MarketRiders e-mail list, below.

“For nearly 40 years, unbiased research from every corner of academia and industry has demonstrated that buying a portfolio of actively managed mutual funds is a “loser’s game” and that the Morningstar 5-Star rating system has little predictive value. Sadly, investors using it have lost billions in retirement savings to unnecessary fees, taxes and under-performance.

A portfolio of actively managed mutual funds is absolutely, without question, as bad for your wealth as smoking is for your health. In 1953, Dr. Ernst Wynder published a groundbreaking study that established the health risks of cigarette smoking. In response, the leading tobacco manufacturers organized a massive counterattack by forming the “Tobacco Institute Research Committee.” What sounded like an unbiased research organization was really a well-funded public relations ploy to calm down the public. For over 40 years, these manufacturers engaged in brutal litigation and campaigns to manipulate public opinion. Finally, industry insiders, Dr. Ian L. Uydess, Dr. William A. Farone and Jerome K. Rivers stepped up and testified against their employer Philip Morris, which forever changed the industry.

For years, the mutual fund industry has waged a similar war against the passive index investment methods that we support. Like big tobacco, the mutual fund industry is large, profitable and immensely powerful. With large advertising budgets to influence “unbiased” mainstream media, they guide investors into bad investments. Morningstar has lined its pockets as a willing accomplice. Mr. Kinnel directs Morningstar’s research and has just announced that their rating system is a little bit better than bogus. In 50 years, will he be heralded as the first industry insider to finally tell the truth?”

Them sound like fighting words to us. What do you think?