Much has been written this year regarding the plight and future of the traditional mutual fund and the companies that manage them. By “traditional,” I mean: the actively managed, open-ended mutual fund, continuously offered to the public at net asset value, where past performance is not indicative of future results! That type.

Alternatives, Exchange Traded Funds, robo-advisors and smart-beta investing have stolen the spotlight as well as a hefty portion of the assets.

To start, let’s acknowledge two main things.

First, the traditional mutual fund and the firms that manage them have a history of evolving. Mutual funds usually provide widespread access to increasingly inexpensive professional investment management expertise, diversification and convenience. By doing that, they have helped preserve savings and create wealth for many in the past.

Second, substantial headwinds buffet the industry; they will force the traditional mutual fund and asset manager to evolve again. Low interest rates and slow organic growth make the need to bend the cost curve both complex and urgent. The DOL fiduciary standard and changes in distribution still must be worked through. Other upcoming regulatory changes might call for significant investment in data management and related technology. Finally, investors’ preferences for low-cost passive products exert competitive pressure.

Nevertheless, the industry is facing these challenges straight on. The evolving nature helps here. Some firms are already responding in ways that play to their signature strengths while rotating to “the new” (“The ‘NEW’ Product, Price, Placement and Performance”).

It remains to be seen how this all plays out. However, I thought I would offer a few words in defense of the role of the traditional mutual fund. After all, it was borne out of and developed over time in response to some real and recognized deficiencies that have sometimes characterized investing.

Growing and Seizing Opportunities

Let’s rewind the calendar. In 1960, 53% of mutual funds were sold with an 8% or 9% sales load, and only 15% of funds were sold without loads.[1] Investing back then was an expensive proposition. Vanguard would not exist until 1974. Given the cost of investing, it’s little surprise then that, by 1980, only 6% of US households held mutual funds.[2] But distribution of the product and the costs of buying them continued to evolve.

In 1980, a unique interpretation of IRS code section 401(k) by a benefits consultant was approved by the IRS. That set up the opportunity seized on by the traditional mutual fund. Workplace savings altered the context in which many individuals saved and invested. (The retreat of defined benefit plans certainly had an impact as well.) Since the traditional mutual fund swept the scene, the product, the market, distribution, technology and investor preferences have changed. For example, see the rise of the collective trust. But the fact remains: the traditional mutual fund, in all its forms, is still at the center of financial security for many investors.

The Pro’s of the Traditional Mutual Fund

Here’s a look at the potential benefits of the mutual fund versus previous models of investing:

Access to Professional Investment Management: Investors receive similar professional investment management that is available to institutional investors.

Diversification: Mutual fund investors can select a fund or multiple funds; this serves as a more convenient vehicle to balance their portfolios versus directly owning the bonds or equities.

Global Reach: A world of investment opportunities is available to investors, which could offer prospects for higher returns and additional diversification.

Democratization: With low minimum initial investments, no minimum account sizes, recurring investment features and share ownership out to three decimal places, the opportunity to save and invest is brought to a wider slice of the population.

Workplace Savings: The 401(k) may not exist were it not for the Investment Company Act of 1940 Act, which regulated the mutual fund sector and built investor confidence.

The Future

Of course, technology and investor preferences have clearly and vigorously challenged the traditional mutual fund. Plus, more change is coming. On that note, here are a few personal observations on the future of traditional mutual funds and the companies that manufacture them:

  • There’s a real possibility that active management could become an important differentiator, especially in a down market.
  • We’ve yet to hear the SEC rule on non-transparent ETFs, which may provide active managers the potential to generate performance in the popular product form.
  • Sustainability investing is emerging at a time when different generations are concerned about the issue and active managers may have an opportunity to lead the charge on it.
  • Technology is the key and active managers are focusing on ways that could improve performance and the client experience, as well as help them be better fiduciaries by using technology to match investing strategies to client needs.

The traditional mutual fund brought an effective and efficient product to many investors. And, looking out over the horizon, ETFs may suffer the same middle-age crisis when investors’ needs change (again) and technology makes even more innovation possible.

Stay tuned. It’s going to get interesting.

[1] SEC – A Study of Mutual Funds, Prepared for the Securities and Exchange Commission by the Wharton School of Finance and Commerce (The Wharton Report), August 1962


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