Jack Bogle is the crusty, venerated founder of investment giant Vanguard Funds.  He has long argued that investment returns are badly hurt by high fees.  Of course, he was right and still is.

For the last 15-20 years, there has been considerable controversy on the question of fees, and marketing types have been quick to confuse the situation by asking if “active” managers actually earn their higher fees.  Or, would clients be better served by simply buying super low-cost index mutual funds or exchange-traded funds (ETFs)?

Passive investing means “owning the market” and not trying to beat it.  Active investing means trying to beat it.  A passive investor, for example, will just buy SPY which replicates the S&P 500 and nothing more.  It owns the 500 stocks of the S&P and holds very minimal cash.

Intuitively, smart educated analysts could avoid weak stocks and concentrate on the strong stock performers.  Active management “ought” to outperform passive index investors.  There have been numerous “definitive” studies on this.  The most recent appeared in The Wall Street Journal in April, showing low-fee ETFs beat high fee mutual funds over the last fifteen years and did so by convincing margins.

Not to get into the weeds too much, but this is where “lies, damn lies, and statistics” start making a difference.  There is such a thing as “survivorship bias,” meaning that time matters — firms come into the market with new mutual funds and then close some of them.  (A few ETFs have done the same but few).  This latest study looked at all funds on the market on January 1st, 2002.  As the weak funds closed down over the next fifteen years, their closing values became zero, badly skewing the performance of the entire group of mutual funds.  In the real world, I’ve never seen a fund go to zero value or 100% loss of client money.  Usually the fund drifts down for a few years, the fund is closed and the remaining investors are paid whatever remains.  That money returned to the investors is not accounted for, which certainly hurts the performance of mutual funds.

Also, the longer the time period, the more likely funds are to disappear.  All past comparisons between actively-managed funds and passively-managed funds (both mutual & ETFs) have been studied over ten year periods.  By extending this study to fifteen years, it increased the survivorship bias, against mutual funds and favoring passive-investing vehicles like ETFs.

The study also did not distinguish between bull markets and bear markets.  Any statistic that says – increasing cash during a falling market is a bad idea – is a bad statistic.

Another factor not accounted for — is the impact of the investor stampede out of actively-managed funds and into passively managed funds.  There is a self-fulfilling issue.  As more investors “drink the Kool-aid” and move into ETFs, it becomes more difficult for mutual funds to remain in business.

Importantly, the study also found that low-fee mutual funds with active management often beat ETFs, but shouldn’t that be the headline?

This is not to defend high-fee mutual funds nor low-fee ETFs.  I have watched feverish debates about large-cap stocks, and I don’t believe there is any benefit to broad mutual funds in this space.  Although the WSJ survey shows that active investing is not more helpful than passive investing in the small-cap space.  I simply don’t believe it!  They don’t receive the analytical scrutiny that large-cap stocks receive.  I like passive-investing for broad sweeps of the market but not for narrow segments.

I enjoy attending the church of index or passive investing, surrounded by all those true believers, and find much to believe in, but I don’t think I will join.