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FA Center: Financial advice is like whiskey: The most expensive isn’t always the best

June 30, 2017
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CHAPEL HILL, N.C. (MarketWatch) — When it comes to investment advice, more expensive is not necessarily better. In fact, it’s often worse.

No, I’m not referring to low-cost index funds. It’s already widely known that those funds outperform the vast majority of actively-managed mutual funds that inevitably charge much higher management fees.

Instead, I am referring to an amazing pattern that exists even among advisers who are trying to beat the market. It turns out that the advisers who charge the most perform no better, on average, than those with the lowest fees. And some studies have found that they actually do worse.

Furthermore, this “no-better-and-often-worse” performance of the more expensive advisers exists even before deducting their higher fees. Net of fees, the advantage often enjoyed by less-expensive advisers is even more evident.

Consider a study I conducted into investment newsletters’ performance over the last 5 years, in which I correlated their track records with their subscription rates at the beginning of this five-year period. Their returns were those that were independently calculated by the Hulbert Financial Digest, according to its standard performance tracking methodology. Their track records were gross of adviser fees, which means that a high-priced newsletter did not have to perform better just to make up its higher subscription cost. That in turn means that, if anything, my study was biased in favor of showing that higher-priced newsletters performed better.

Yet I found the opposite: My PC’s statistical software found no correlation between price and performance — as is visually evident from the accompanying chart. Some high-priced services performed creditably, but many did not — just as was the case for lower-priced newsletters as well.

It’s important to interpret this result accurately. It does not mean that you should automatically avoid the highest-cost advisers and instead go with the cheapest ones, for example. The lack of a correlation means just that: An adviser’s management fee tells you nothing about the likelihood of his being able to beat the market.

The only time when price becomes relevant is when you have narrowed your search for an investment adviser down to two who are otherwise identical in all respects except their fees. Since price is irrelevant to subsequent performance, you would therefore be on solid ground going with the lower-cost adviser.

Otherwise, your attitude should be: A higher-priced adviser is worth it if he beats the market, and otherwise worthless. And, needless to say, the same is true for advisers with low fees.

When I have advanced this argument to clients, some wonder if my results are a function of the newsletter world on which I focus. Among more “professional” and “established” advisers, some of them argue, might I find a correlation between price and performance.

I don’t think so. The same conclusion emerges when analyzing other types of investment advisers.

Take mutual funds that charge a front-end load, for example. The available evidence suggests that, even before taking into account the impact of those loads on an investor’s performance, the average load fund has performed less well than the average no-load fund. The most recent of those studies of which I am aware was published in 2004 in the Journal of Banking and Finance, authored by Matthew Morey, a finance professor at Pace University. As was also found in prior studies by other researchers, Morey found that “no-load funds outperform load funds before adjusting for the commission” — though, he added, this difference is not always statistically significant.

In a recent email, Professor Morey told me that he is unaware of any study that has updated his analysis with more recent data, but added “I am relatively sure that no-load funds still carry the day.”

By the way, this pattern exists outside the U.S. as well. A study that compared Canadian load and no-load funds also found that load funds do not “outperform no-load funds, even when loads are ignored.”

And no discussion of fees would be complete without considering hedge funds, which are at the most expensive end of the fee spectrum: They typically charge both 2% of assets under management as well as 20% of any profits. Particularly revealing is the performance of so-called funds of hedge funds, which employ professional staff to sift through the often complex statistics involved in assessing hedge fund returns to identify those few that have the best bets for future performance. Yet David Hsieh, a finance professor at Duke University, has found that just 2% of such funds in the past earned enough to justify paying their fees.

The bottom line: Don’t make the mistake that whiskey drinkers are known to often make, thinking that more expensive whiskey tastes better. It might be that a high-priced adviser is worth following, but don’t automatically assume that his high price means he’s better.

For more information, including descriptions of the Hulbert Sentiment Indices, go to The Hulbert Financial Digest or email mark@hulbertratings.com.

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