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Originally published Saturday, July 19, 2014 at 8:00 PM

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Don’t fall for complex new fund types

The fund industry is under constant pressure to develop new products and services — often just twists and variations of old products and themes — resulting in a near-constant stream of offerings, most with little benefit to the public.


Syndicated columnist

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Your Funds

Walking through the exhibit hall at the recent Morningstar Investor Conference felt a bit like watching a marathon of “The Dr. Oz Show,” filled with fantastic claims about products designed to improve your financial health.

There are new mutual funds that are built to ease whatever is troubling your mind — and your portfolio — by mitigating risk, reducing volatility, enhancing return and more.

They’re not making fantastic or outrageous claims that violate the law, but they are working hard to attract zealous followers — financial advisers mostly — who will then sell you on how these new issues will help to cure your financial ills.

To be sure, ideas like “smart-beta funds,” “multistrategy alternative funds,” low-volatility funds, managed futures funds, market-neutral or long/short funds and more are not financial quackery. The strategies behind each of these ideas have merit; I have no doubt that, used properly, they can diversify a portfolio precisely as advertised.

But if you are a typical investor, the question is whether they have merit for you.

It’s a bit like high-level power tools. In the hands of a skilled worker or carpenter, they make the job easier, faster, more predictable and likely to be finished as expected and imagined.

In the hands of a wannabe or a wishful thinker, they could work, they could cause frustrations that botch the job or they could cause a trip to the emergency room.

The folks behind these new products don’t really deny this.

They will tell you that their sophisticated newfangled ideas wind up creating the power tools that savvy financial advisers use; if you’re an average investor, you’re not going on this ride unsupervised, your trip is chaperoned by the adviser so you aren’t misusing the product.

But increasingly, these kinds of alternatives are winding up in retirement plans, and while the plan sponsor may understand the benefits, proper uses and potential dangers of these things, the average worker doesn’t.

They have a difficult enough time making plain-vanilla funds work — studies show that investors routinely buy their funds high after a run of strong performance and sell them low when there has been a pullback — let alone something they barely understand.

Moreover, while these solutions are always pitched as being good for investors, the people for whom they are always good are the pitchers, the brokers and planners pushing them.

While it is appropriate, given the investment’s complexity, that these products are sold by brokers and advisers, it’s important to remember that most of those counselors are permanently on the lookout for something new to attract and retain clients.

Thus, the fund industry is under constant pressure to develop new products and services — often just twists and variations of old products and themes — resulting in a near-constant stream of offerings, most with little benefit to the public.

I talked to a number of financial advisers who said the real key is less about what is being offered and what it can do than in how well the investor knows their own ability to create and follow a plan.

If you can invest for the long haul and not touch the asset-allocation plan other than for rebalancing no matter what is happening on the market, then a big slug of alternatives or hedgelike mutual funds isn’t necessary.

If you will be freaked out by the next market burp, correction or downturn — and are likely to make hasty moves as you perceive the market to be unraveling your plans — then you want to take a more tactical approach using some new issues to cut risk and/or volatility.

Of course, the problem there is that you may panic out of those funds at exactly the wrong time, too.

What’s more, to get the value of these funds, making them a small portion of the portfolio isn’t always smart; instead, to get the kind of results the experts say these funds can deliver, an investor might need to take a significant step in the direction of these new funds, which is a big leap of faith.

“We can be very dubious about some of the new products,” said Michael Falk, chief strategist at Mauka Capital in Chicago. “That doesn’t mean they can’t help you, but what’s the marginal benefit? If you’ve got to put 20, 30, 40 or 50 percent of your assets in a certain newfangled investment for it to benefit your overall portfolio, we have to ask the question ‘Is the average person going to do that?’

“If they’re thinking because it’s new and improved and fancy and sophisticated, that they’re only going to put 5 to 10 percent in — if it’s not going to make a marginal contribution to the portfolio — then ... why bother?”

Of course, the advisory community has reasons to bother with the new products, but make sure they’re not just pushing a bill of goods, something that seems great today that they will be encouraging you to replace with another “current” product months or years down the line.

Examine their history when it comes to appealing to your sense of adventure or your willingness to try the next big thing.

Taking a chance on these new ideas is fine, but don’t make a habit of it without seeing some results.

Adding complexity to a fund adds to costs and changes the risk profile of a portfolio. It increases the likelihood of future mistakes.

The fund industry was started to give investors diversification and professional management at a reasonable price, and plenty of issues still do that.

When looking at a fund that does not provide those basic characteristics — because it is supposed to be giving you something much more complicated and important — question whether it’s worth the adventure.

But don’t expect that today’s new fund classes or the catchall of “alternative investments” is a panacea for your portfolio.

It’s more like an option that you can take, but which may not deliver results that equal the hype.

Chuck Jaffe is senior columnist for MarketWatch. He can be reached at cjaffe@marketwatch.com or at P.O. Box 70, Cohasset, MA 02025-0070.

Copyright 2014, MarketWatch



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