Active vs. passive investing:
Feb. 21, 2003 interview with the Genslers
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GIBBS: Beating the S&P -- It seems to have become our national obsession, and it's something these two men have very strong feelings about.
 No, you're not seeing things. Gary and Rob Gensler are identical twins, born just three minutes apart, but their views on investing couldn't be farther apart.
On the left, Gary, former Undersecretary of the Treasury, whose book The Great Mutual Fund Trap lambastes the $6 trillion mutual fund industry for creating the myth that star managers can beat the market. On the right, Rob, a star manager at T. Rowe Price whose Media and Telecommunications fund is tops in his category, but still down 28 percent last year. Rob says he has not read his brother's books.
Gentlemen, start your engines. Thanks for joining us.
Well, Gary, you level some pretty serious charges against the mutual fund industry. And in fact, let's look at some of the most serious. As for great stock pickers, you write, "The returns for money managers are like those of people who flip coins." And is that before or after the charges?
G. GENSLER: Karen, it's a little bit like Las Vegas, actually, because it's before all the costs. I mean they serve you the nice drinks. You might even get a nice hospitality suite in the evening if you lose enough money, and many a mutual fund will actually give you free parking if you give enough money to them.
But really when you look at all the statistics, four out of five mutual funds -- that's four out of five over a 5-year period of time -- fail to beat the market. And all I want to do is have a chance to at least tie with the market rather than chasing after excess returns that are so hard to get.
GIBBS: Rob, what do you think about that? You've done pretty well in your career at T. Rowe Price.
 R. GENSLER: The intriguing thing is there's a lot of truth (to Gary's assertions), because it's statistics, obviously.
But most mutual funds actually have charters and agendas that aren't the market. Many are large cap, some are small cap, some are growth, some are value. So to judge them across the broad market is a bit unfair because you're judging them versus not their actual, true challenge that they're trying to do. And to say there aren't star managers is like saying there aren't star ball players, okay? You could statistically say that Barry Bonds' home runs happen only by chance because he's hit so many, but you could flip a coin so many times and somebody would hit home runs.
I choose to believe Barry Bonds actually has some excellent ability. You could choose to say it's just luck.
GIBBS: A lot of people like him on that team.
Well, talking about fees, you also say, Gary, that "Fund managers run with ankle weights that could have brought down Carl Lewis." And that's in the running shoes, not the high heels, right?
G. GENSLER: It's true. It's really remarkable how much we Americans give to the mutual fund industry. It's over 3 percent a year. About half of that's in the fees. Even Rob's fund is probably about 1 percent a year. But then in addition they trade so much. The stocks are being bought and sold so much that all of a sudden that adds costs, and then there's all those taxes when the market's going up, when you hope it's going up.
And it adds up to about 3 percent a year, so it's very heavy ankle weights.
I do believe that Barry Bonds hit 600 home runs and is keeping going because he's got talent. I believe Rob has talent. But when you weigh it down with those ankle weights of 3 percent a year, it's awfully hard for the investors, for your viewers to be able to beat the market through the mutual fund industry.
GIBBS: But you do get what you pay for don't you, Rob? And isn't it right that the mutual funds charge some sort of fees for the service that they provide?
R. GENSLER: Yes, but actually, my brother brings up a good point, (which) is, you've got to be aware of the different fees. And there's different structures of mutual funds. There's no-load, which means they charge no load up front to buy the funds, which tend to be cheaper to the consumer, and there's firms that have better processes, that are large enough to do the broad research necessary to have better results. So there's all kinds of different funds and different ability in different fund complexes.
GIBBS: So it's still up to the individual investor to basically do their homework and get the best for their money.
R. GENSLER: Yes.
G. GENSLER: And yet when you do that homework, past performance does not predict the future, because the mutual fund industry is going to advertise their hot funds of yesterday. Those hot funds are not often the ones that do well in the future. And in fact those 10 great stocks that you talked about, those Johnson & Johnson's and so forth, if they did great last year, often that does not mean they're going to do so well next year.
GIBBS: But also, isn't there something to be said for a great track record, Gary? I mean you do want somebody that has the time and the history and the experience in the market, don't you?
G. GENSLER: Well, I like experience and understanding the markets, but I also like to make money, and unfortunately that experience you usually pay a lot for, and again, it doesn't predict the future.
If you're a 5-star rated Morningstar -- that's this company that rates these funds -- you have 5 stars one year, ignore that, because next year often it sort of floats down and it's 4-star or 3-star. And so past performance does not predict the future.
GIBBS: Do you buy that? Do you agree with that statement your brother just made?
R. GENSLER: I agree when you broadly look at it and don't look at the facts of -- you know, you've got to look and say, what's the stability of the complex, the stability of the professionals in the complex, and even the stability of their effort? The reason the past performance is such a poor predictor is many of the portfolio managers get reassigned. They either leave the organizations or they get reassigned to a different fund. And again it gets down to the organization that you're investing in and the process within the organization: Is there stability to the process and do they have a broad enough reach to understand the broad investment arena?
 GIBBS: Now when you look at a 10-year time span, we do see that index funds outperform actively-managed funds. Why is that?
R. GENSLER: Well, in the past 10 years, actively-managed funds, many of them carry a bit of cash because they have no choice but to carry cash, and it makes it hard.
But again, it's very unfair to judge funds that all have different charters versus saying do they beat the S&P, the market, the Wilshire 5000, okay? And almost every fund manager is actually measured against very strict benchmarks that are different than the market, and most fund managers, if you judge them against their individual benchmarks, they have much better results.
GIBBS: Gary, are you painting with too broad of a brush here?
G. GENSLER: I think not. I think that Carl Lewis, as great a runner as he is, if he's weighted down isn't going to be able to beat the world record.
 And the chart that you just showed is because of all those expenses and trading costs. And just like businesses right now need to go back to basics, go back to lower costs and diversifying across the market. The best solution is really to diversify across the entire market at the lowest cost, and you can do that at one-tenth the cost through index funds. You can do it at 0.2 percent instead of almost 10 times that when you add up all the costs of the actively-managed mutual funds.
GIBBS: Maybe that works in bull markets, but in bear markets, I don't really want to mimic a fund that's just going to lose me 20 or 30 percent. I'd rather go to Neiman-Marcus. What do you say about that?
G. GENSLER: I say if you can predict when the next bull market is going to be, you should be in the market, and if you can predict when the next bear market should be, you shouldn't just be on this TV show. You should be...
GIBBS: I'd have my own private island.
G. GENSLER: Yeah, you'd have your own private island.
A lot of people say that index funds are not the story when the market's going down, and I would say, not really so. Now in the last 18 months, active managers have in fact done well, but that's one 18-month period, and hopefully you're saving for retirement, which is a 20- to 40-year period of time, not an 18-month period of time.
GIBBS: Right. Your brother's taken some pretty good potshots at the industry, but one thing I might want to ask you about is the role the financial media has played in this whole thing. Can you address any of that, Rob?
R. GENSLER: Well, the financial media tends to play up the hot funds, as he's saying, so they almost accentuate some of the issues he's talking about.
But I have to retort on one thing. He's double and triple counting the costs, because the commissions come out of the returns, so you really have to look at just the fee structure. And even the returns are net of fees, so often when you look at the returns relative to some benchmark, you're seeing it net of those costs. Okay so, and again, it's about process. And index funds, although they serve a great role, they're not necessarily the entire investment picture.
GIBBS: All right. Rob, Gary, we've got to leave it at that. Thank you very much for joining us.
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