My 33 Investment Years
What an unexpected ride it has been!
When I started working at Morningstar (MORN), on Feb. 15, 1988, the mood was subdued. Reeling from stocks’ 22% loss on Black Monday (which remains the largest single-day decline in U.S. stock-market history), investors feared the good times were over. Both equity and bond prices had enjoyed a splendid five-year run from 1982 through mid-1987. Now, it seemed, normalcy would return.
Instead, the rocket ship arrived. The stock market went almost straight up, year after year, with inflation and interest rates heading down. The fund business followed suit. Historically something of an investment backwater--entering the 1980s, the industry’s annual revenues were under $500 million--mutual funds hit the mainstream. It was all very exciting. I was particularly happy because shortly after joining the firm, I had ignored the skeptics and placed everything I had (not much) into a fully invested stock fund.
In the early years, Morningstar analysts wrote reports on every existing stock fund, including the $5 million Valley Forge Fund, operated by a husband-and-wife team. (“Bernie can’t come to the phone now. Can I have him call you back, after he finishes mowing the lawn?”) Attempting the same feat today would require a much larger research team. Including exchange-traded funds, the equity fund count has octupled.
Although impressive, the increase in the number of funds has greatly lagged the surge in fund assets. In 1988, the largest mutual fund was Franklin U.S. Government Securities (FKFSX), which finished the year with $11.7 billion. (Close behind was another bond fund, Dean Witter U.S. Government Securities Trust (USGAX), which has since been renamed after its current owner as Morgan Stanley U.S. Government Securities.) Today, 348 mutual funds and 124 ETFs exceed that figure.
The following chart, contrasting mutual fund assets in 1988 with those for 1) mutual funds and 2) ETFs in 2021, effectively conveys the story. When I first arrived at work, the industry’s advance had only just begun.
Yes, those numbers are not inflation-adjusted, but doing so would merely bump the 1988 figure to $1 trillion. That initial year would still barely register on the chart.
Besides breathtaking growth, the other remarkable fund development has been the triumph of indexing. In 1988, three index funds existed: 1) Vanguard 500 Index (VFINX), 2) DFA U.S. Micro Cap (DFSCX), and 3) a brand-new entrant from Fidelity that was eventually merged into the company’s current offering Fidelity 500 Index (FXAIX). (Even that list is suspect, as DFA now states that its funds are actively managed. However, as it called DFA U.S. Micro Cap an index fund at the time, that is where I have placed it.) In aggregate, those funds held $2 billion, making for a market share of slightly under 0.5%.
Today, index funds account for more than half of equity fund assets and just over 40% of the overall industry. That percentage surpasses my seemingly rash prediction from the early 1990s that indexers might eventually control 30% of the fund business, which I had flippantly offered to a Money reporter. That became the story’s main quote. Active managers were, shall we say, unamused.
Accompanying index funds’ advance has been greater awareness of fund costs. Back in the day, investors who emphasized fund expenses were viewed as cranks. Life was too short to worry about a few basis points. In 1993, for example, the five top-selling mutual funds carried average an average expense ratio of 1.09%. When performance was strong, price was not a barrier.
That attitude has sharply changed, as reflected not only in today’s best-seller lists-- which are dominated by index funds--but also in the industry’s average dollar-weighted expense ratio, which reflects where investors now hold their monies. That has dropped sharply, from 0.74% for all stock, bond, and allocation funds in 1988, to 0.41% for mutual funds today, and a piddling 0.17% for ETFs. Whereas both direct investors and financial advisors once downplayed the importance of price when evaluating funds, they now place expense ratios front and center.
Admittedly, the all-in costs for fund investors haven’t dropped as dramatically as the numbers would seem to indicate. Today’s financial advisors are compensated differently. Whereas they once were almost exclusively paid by fund companies, which embedded sales charges into their products, advisors now mostly charge asset-based fees. Thus, many fund investors pay more than the figures suggest. On the other hand, their interests now align with their advisors’. For each party, the cheaper a fund, the better.
Indeed, now that they have become discount shoppers, financial advisors prefer using institutional shares. After all, why should their clients pay more, when advisors can use their insider status to arrange better deals? That the industry has become so large, with prominent advisors placing tens of millions of dollars with a single fund group, has strengthened their negotiating power. As a result, fund companies have increasingly made their institutional shares available to all.
The fund industry’s boom greatly benefited Morningstar. My career has therefore been blessed. While most people from my generation have not enjoyed similar working conditions, all were granted the same terrific investment opportunity. The fund business was not alone in outstripping expectations. So, too, did stock and bond performances, which easily outpaced inflation. Those who held bonds profited. Those who held equities fared better yet. Many became wealthier than they ever would have imagined. The chart below provides the details, for the 33.5 years that have passed since Aug. 1, 1988.
Whether the upcoming generation will enjoy similar investment success remains to be seen. The consensus is otherwise. Most institutional researchers expect the after-inflation returns for both equities and bonds over the next one third of a century to fall far short of what the most-recent third delivered. That may well occur; I don’t argue with the forecasters. However, it’s worth remembering that when my personal journey started, the wise old heads sounded the same note. As Yoda would say, wrong they were.
Happy holidays, and may your fortunes be as generous as mine have been.
Editor's Note: The reference after Exhibit 2 to the 1988 figure was corrected to trillion, not billion.
John Rekenthaler (email@example.com) has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.
John Rekenthaler has a position in the following securities mentioned above: MORN. Find out about Morningstar’s editorial policies.