Gensler Gary S. - The Great Mutual Fund Trap: An Investment Recovery Plan

GREGORY BAER AND GARY GENSLER

Broadway Books | New York

Contents

For the women in our lives
Francesca, Shirley, Anna, Lee, and Isabel
and
the three baers
Jack, Matt, and Tommy.

They give us purpose.

Acknowledgments

W e were only able to write The Great Mutual Fund Trap with the assistance of many other people. In particular, we have one institution, two companies, and a lot of people to thank.

The institution is the U.S. public library, in particular the Library of Congress and Fairfax County Library, George Mason branch. If you haven't visited a library recently, you may be unaware that on-line databases now allow you to access practically any newspaper or periodical, going back decades.

Morningstar, Inc.'s comprehensive Principia Pro database is the source for much of our research on mutual fund performance. Much of this data is also available on the Morningstar website.

RiskMetrics Group, Inc., is a company dedicated to the measurement of risk, believing as we do that return is only half the equation. At RiskMetrics, Ethan Berman and Greg Elmiger provided great help, particularly in analyzing the Wall Street Journal's Dartboard Portfolio.

Daniel Greenberg at James Levine Communications was an able guide through the maze of publishing, and good company to boot. Jim Levine was good enough to pluck our proposal from the slush of unsolicited manuscripts. For that alone we'll be forever grateful.

At Broadway Books, Suzanne Oaks, our editor, recognized immediately what this book was all about. Suzanne and Claire Johnson provided helpful edits and gentle nudges. When Suzanne moved on to greener pastures, Trish Medved became our guide, and helped us negotiate the end stages of the process. Rebecca Holland, our production editor at Broadway, maintained her professionalism and sense of humor in the face of a barrage of last-minute edits by nervous first-time authors.

We are indebted to our research assistant, Nataliya Mylenko. While working on her Ph.D. in finance, she spent countless hours researching historical performance data on hundreds of stocks. Her work provided the foundation for Chapter 10 on the Wall Street Journal's stock picking contests.

Many people, not all of whom are eager to be named, have been kind enough to review the book and give us comments. Steven Schoenfeld was an informed and patient guide to the world of exchange-traded funds and indexing more broadly. Leslie Buckland, Doug Carroll, Stan Crock, Ed Demarco, Jane Gensler, Bill Grace, Bob Grusky, Bill Lang, Joe Minarik, Eric Mogilnicki, Peter Orszag, Ronni Rosenfeld, Paul Sagawa, Alan Summers, Larry Summers, Steven Wallman, and Leslie Woolley presented valuable review. Arthur Baer reviewed the early drafts and provided much-needed encouragement. At the earliest stages, Anna Gensler convinced her dad that he simply had to write this book. Rob Gensler, a very successful money manager, provided important support even as his identical twin brother's project questioned the very nature of his industry.

We are both fortunate to have married women smarter than ourselves. Francesca Danieli and Shirley Sagawa were, aside from their many other contributions, invaluable editors and sounding boards.

At this point in most acknowledgments, you'll see the authors note that, despite the myriad contributions of others, they are solely responsible for the contents and solely to blame for any errors. Having spent a few years in politics and government, we aren't about to fall into that trap! To anyone wishing to point out mistakes or assign blame, we say, Haven't we had enough of the politics of personal destruction? Have you no decency? That and, We're sorry.

A Note from
the Authors

Y ou may wonder why two guys like us would write a book about personal investing. We don't have any business to promote. We're not financial planners or brokers. Furthermore, given the things we have to say about the current state of money management, we're unlikely to make a whole lot of new friends. So why?

Initially, the reason was frustration. While serving at the Treasury Department during the Clinton administration, we undertook a review of the investment performance of the Pension Benefit Guaranty Corporation. The PBGC is the federal government entity that stands behind the corporate pensions of millions of American workers. It had been actively investing in stocksthat is, hiring managers to beat the marketsince 1976. The performance was remarkably poor. A dollar invested by PBGC in 1976 would have returned 44 percent more by 2000 if it had simply tracked the market. Moreover, the PBGC earned these below-market returns while investing in stocks that were more risky than those in the broad market.

While the size of the lost earnings surprised us, the nature of the problem did not. While at Goldman, Sachs, Gary would often be asked for stock-picking advice. He always responded that passive investment was the best option, though his friends and family mistakenly thought he was being coy. While working at the Federal Reserve, Greg had some of the nation's best economists explain to him the folly of trying to beat the market. To our chagrin, though, we discovered that not everyone was inclined to see it this way. Our efforts to effect reform at the PBGC were successfully blocked by those with a vested interest in the existing system.

We therefore felt the urge to alert consumers to the traps awaiting them in financial markets. We knew that the average individual investor was probably paying more for active fund management than the PBGC and faring even worse. That said, we wouldn't have written this book if there were not good alternatives to the current system. Fortunately, we knew of wonderful new opportunities for investors to improve returns and diminish risksopportunities that we believe most investors don't yet fully appreciate. So, we offer The Great Mutual Fund Trap as both a revealing look into the current system's failings and a promise of a better way.

We hope that as you read on, you'll have a few laughs and enjoy the everyday examples we use to illustrate complex financial concepts. We think investing books should be fun and interesting. That does not mean, though, that we believe investing itself should be fun. Interesting, yes, fascinating maybe, but to us fun is finishing work on your finances in time to throw the ball with your kids or read a good novel or call an old friend on the phone. Here's a good rule of thumb: if you're having fun investing, then there's a good chance that you're not properly diversified, you're trading too much, and you're taking too much risk.

Greg Baer and Gary Gensler