Capital Research Cops Out

Capital Research & Management is one of the smartest, best-run, and most successful mutual-fund management firms in the business (Capital runs the American Funds).  In yesterday’s WSJ story on mutual-fund streaks($), however, a Capital vice president invoked some weak logic when explaining a fund’s performance relative to that of the benchmark:

"We don’t manage the fund with the objective of trying to beat the benchmark," says Drew Taylor, a vice president at Capital Research & Management Cos., which oversees the American Funds. The objective, instead, is to deliver, "over long periods of time, current income and growth to shareholders."

There is no shame in trying to provide "current income and growth to shareholders."  The cop out comes from the pretense that it is doesn’t matter how the fund performs relative to the appropriate benchmark.  Given the wide availability of low-cost passive funds designed to track almost every conceivable benchmark, the only reason for fund customers to pay higher fees for active stock-picking services (such as those provided by Capital Research) is to try to beat the appropriate benchmark.  If an active fund fails to do this, it has cost the fund-holder money relative to the cheaper passive product, no matter how much "income and growth" it has generated. 

The fact that most mutual-fund buyers don’t understand this allows most fund companies to fall back on an intellectually weak defense ("It’s okay that we lagged the benchmark, because we weren’t trying to beat it.")  This, in turn, allows the active fund industry to continue to coin money while its stock-picking services actually subtract value from most clients’ portfolios. 

There is no fraud or subterfuge here: Active fund companies are just taking advantage of fund-customers’ ignorance to set low success hurdles for themselves.  But make no mistake: Because the vast majority of active funds underperform low-cost passive funds, the most client-oriented move for most fund managers would be to fire themselves and put their clients in passive funds.  For obvious reasons, few will do so.