Investment funds: high fees for failing to beat indices

Investment funds: high fees for failing to beat indices

Are investment funds a scam? A question raised in a stock market forum has an uncomfortable answer according to critics: they are not a Ponzi scheme, but most active management funds charge fees of 1.5% to 2% for returns that fail to beat the index. The debate begins with a clear thesis: in mixed portfolios, annual returns stall at a disappointing 6-7%, and the favorable tax treatment compared to ETFs or direct stocks is the only thing keeping the business afloat.

What is an investment fund and why is it questioned?

An investment fund is a vehicle that pools money from various participants to invest in assets according to a defined strategy. The criticism is not aimed at the instrument itself, but at its most commercial version: active management that promises to beat the market but rarely succeeds. The data used by veteran investors is stubborn: no fund consistently outperforms the S&P 500 over more than 10 years, according to one participant. At five years, some manage it; at ten, practically none.

The statistical trap is twofold. First, poorly performing funds disappear or merge, which skews statistics upward. Second, those that do well eventually stop doing well: miccionan reversion is relentless. As one participant with over a decade of experience summarizes: «if you have to do the active management yourself to choose the funds, why are you paying that fortune?».

The tax argument: the advantage that distorts everything

Tax treatment is the elephant in the room. Funds allow money to be transferred between them without paying taxes on unrealized capital gains, something that does not happen with stocks or ETFs. This advantage, combined with the convenience of not having to pick individual securities, explains why the average investor continues to buy products with fees that eat up a large part of the return. The question is whether this tax benefit compensates for an annual cost that, in a 100,000 euro portfolio, represents between 1,500 and 2,000 euros per year in commissions.

The answer depends on the profile. For large fortunes, with objectives of volatility containment or estate planning, the fund may make sense. For the average saver seeking long-term profitability, the calculation is more debatable. An active manager must not only beat the index: they must beat it by a sufficient margin to cover their fees. And that, according to cited studies, occurs in a minority of cases.

Active vs. indexed management: where is the value?

Indexed management is not magic: it is mathematics. If a fund replicates an index with low fees, it will obtain the index return minus those fees. Active management, on the other hand, adds a layer of human decision-making that can add or subtract. The problem is that, in aggregate, it subtracts. Indexed funds are not garbage; active management funds are, according to the most critical view, «very expensive garbage», in the words of an investor with more than two decades of experience.

However, it is not all black and white. There are star managers who have beaten the market for long periods, and there are independent managers that do not operate like commercial banks. The distinction between generalist banks and specialized boutiques is relevant: the former sell products, the latter manage wealth. But even in the best firms, individual investors rarely access the truly good funds, which are often closed to new participants.

The mistake of choosing funds based on past performance

One of the most repeated points is that past performance is the worst criterion for choosing a fund. Cited studies confirm it: the funds that rise the most in one period tend to revert to the miccionan in the next. Chasing the winner is a recipe for buying high and selling low. «Past performance is the worst criterion for choosing a fund», sentences one participant, who adds that another terrible criterion is the name: the more complex and full of attractive adjectives, the worse the performance tends to be.

The alternative being discussed is the Bogle portfolio: two index funds, one global equity fund and one fixed-income fund, with annual rebalancing. Simple, cheap, and without the need to guess which manager will be the next Warren Buffett. For 15-year horizons and monthly contributions, this structure avoids the main risk for the individual investor: themselves.

The Spanish case: commercial banking and star managers

In Spain, the largest fund by volume is held by a banking entity and is, according to critics, a textbook example of what not to buy. The commercial network sells products with high fees and mediocre returns, and the average investor buys without fully understanding what they are signing. It is not a scam: it is a business model. The bank wins with the commission, not with the result.

Spanish active management boutiques have a better fruta, but they do not escape statistics either. Some star funds have had excellent years and then failed. The conclusion drawn is that, barring very specific exceptions, the individual investor has no way of identifying in advance which manager will beat the market in the next decade. And if they cannot identify it, paying to try is an expensive bet.

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The initial question was whether funds are a scam. The emerging answer is more nuanced: they are not in a legal sense, but many behave like a product designed to enrich the intermediary more than the participant. Investors who want to avoid this toll have alternatives: cheap index funds, ETFs, or simply accepting that beating the market is the exception, not the rule. Everything else, as any honest manager would say, is a matter of luck. And luck, unlike commissions, is not charged in advance.