10 Questions: Is Your Fund Family the Enemy?

4. You decry the practice of load funds, and you discuss the negative effects on returns extensively in your book. Would you elaborate on your findings?

The book demonstrates that you aren't getting less than nothing in return for the loads, or sales charges, that you pay for these funds.

The returns of load funds in the aggregate are lower -- 0.48% a year less on average. The reason is their expenses are higher. Almost all load funds also carry 12b-1 fees [an additional fee the SEC allows to pay for advertising]. It's simple arithmetic, and those returns don't even take into account the load itself.

5. One of the most damning points you make about actively managed funds in the book is the chart from the indexing firms S&P and DFA that track "five-year winners" over the subsequent five years. What did you find?

The chart examines the 30 best-performing funds in any given five-year period going back 30 years. In the subsequent five-year periods, that group of 30 funds sometimes trailed the average fund, sometimes beat the average fund. But it always trailed the S&P 500.

There are at least three factors at work here. First, the performance of active mutual fund managers is random. People think there are patterns; people think that there is persistence -- there is no persistence, on a statistical basis. It's random.

[Legg Mason Value Trust manager] Bill Miller is a very smart guy, but the fact still remains that on a coin-flipping basis, one of them is going to beat the S&P for 11 years running, as Miller has. It's the luck of the draw.

Second, when you buy a winner for the past five years, you're buying a hot asset class. Asset classes tend to revert. It's a losing strategy. You're buying the best-performing classes for the past five years, which tend to underperform for the next five years.

Number three, you've got asset bloat. It gets harder to reposition the portfolio. Returns are going to suffer. If you want to sell a billion dollars of IntelINTC, you're going to take it in the shorts.

6. Let's talk about index fund investing. While you are an index fund adherent, you also mention that the S&P 500 has gotten "too popular." Would you discuss the potential pitfalls of investing in 500 index funds?

I don't want to put the S&P 500 down as a vehicle in someone's investment policy. I think it's a good proxy for large-cap U.S. stocks. I think it should be the core of most investors' portfolio.