The Mutual Fund Fraud

Via Felix Salmon, some Fama and French empirical work on the (lack of) returns to actively managed mutual funds.

Here’s how fund managers do before fees relative to a hypothetical zero skill case:


Some managers do worse than random, others do better. But what if you account for fees?


Now everyone looks bad.

At any rate, the basic result here is pretty well-known. But one thing I’ve always wondered about it is why does this result have so little impact on economists’ thinking? After all, this is not a controversial conclusion among economists nor the result of some unorthodox research program. Both proponents and critics of the efficient markets hypothesis tend to agree about this. And yet, the existence of a large and lucrative mutual fund industry, as well as very active and profitable enterprises purporting to offer investment advice (see, e.g., Jim Cramer) seems to go against most of what economists claim to believe about the rationality of market participants. Of course the economy is widely understood to include various petty scams—tarot card readers and the like—but they mostly seem pretty marginal.

Mutual funds, however, aren’t marginal at all—this is a lot of money we’re talking about. So how does that happen? And why isn’t anyone doing anything about it? All these government-sponsored savings vehicles—401(k), IRA, etc.—should be set up to strongly encourage people to put their money in indexes. It’s bizarre that the government is, by bipartisan agreement, basically complicit in encouraging people to funnel their savings into elaborate frauds. Why not teach this material to high school and college students?