May 1, 1999
Prem Jain has a simple investment strategy: put your money into broad-based index funds and forget about it. It is a message that he insistently tells his students and one that he also would like Tulane University to embrace.
Jain, the Exxon Professor of Business at the Freeman School, debunks the notion that professional money managers can shrewdly plot an aggressive investment strategy that will, on average, perform better than indices such as Standard & Poor's 500, which comprises a broad variety of industries.
"There are currently more than 6,000 funds available for investment," says Jain. "There is no proof or evidence to suggest that one type of fund does better than other types."
Jain likens the large index funds such as Vanguard 500 to a retail outlet such as Walmart that advertises everyday low prices.
"You don't have to run around looking for bargains," says Jain. Which is good because, according to Jain, there are no bargains--or at least very few of them--in the stock market. It is a concept that many of his students initially find hard to accept.
"Students feel uncomfortable in hearing this," says Jain, who believes that most mutual funds do not perform any better than the passively managed S&P 500 and only very few money managers are consistently credible. "People don't want to believe this because they are accustomed to seeking out experts," says Jain. "If we are sick, we go to a doctor. If our pipes need fixing, we go to a plumber. So when money has to be managed we go to the experts. But this world is very different."
It also is a world that is often driven by advertising, says Jain. Mutual fund managers will often advertise their successful funds to persuade potential investors that the funds' success will continue in the future. Track records, however, are poor indicators for future performance.
In research he has conducted over the last five years, Jain and graduate students collected ads appearing in Barron's and Money Managing trade magazines and watched the subsequent performance of the advertised funds.
"We compared them to the S&P 500 index as well as to some other benchmarks. Basically, they underperform the index by 2 to 3 percent."
This is consistent with other research. In a paper he co-published in Journal for Finance in 1995, Jain illustrated that the recommendations of so called "superstar money managers" such as Mario Gabelli, Peter Lynch, and others did virtually no better than the market (12.13% vs. 11.93%) during the same period of time.
During a presentation to the University Senate Budget Review Committee in April, Jain asserted that Tulane might save as much as $15 million in its endowment each year if it would do away with all aggressively managed funds and invest in two index funds, one stock fund and the other a bond fund.
"People's first impression is that it is too naive to think in terms of only two basic funds," says Jain, "but I think it is as good as it gets. Surprisingly, it is the best thing to do."
Jain points to mistakes made by money managers as well as direct and indirect expenses incurred by retaining money managers as reasons for the poorer net results from actively managed funds. Jain, who has expressed his investment philosophy to the Tulane Board of Administrators Endowment Management Committee in the past, is heartened that in the last two years Tulane has moved a portion of its endowment to indexed funds.
"We moved to a Vanguard index fund in June '97," says Yvette Jones, senior vice president for planning and administration. Before that, says Jones, the university's investments had not been hitting the S&P 500 benchmark.
Jones, who says Tulane is moving away from investment strategies that have caused its earnings to lag behind the market during the last decade, says that the university is in the process of restructuring its endowment.
"We have reduced our foreign equity position and we've moved away from an aggressive fixed-income position," says Jones. "We have let some managers go and have taken those dollars and put them into this Vanguard fund."
Jones says certain current long- term investments make having just two index funds "unrealistic," yet she believes the "core of the endowment" should be in a large index fund. "But I do think we need to have some managers in some specific and special areas," she says. According to the data provided to the Senate Budget Review Committee, Tulane's current endowment fund was valued at $513,371,380 as of Feb. 28, 1999. Of that, approximately $140 million was in an index fund.
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