The Economist’s July 5^th, 2003 issue carried an extended special report on the state of the asset management industry. By and large, it was about what you’d expect, and it didn’t tell you much that you didn’t already know from your own experience.

The piece did, however, feature two transcendently wonderful charts, which I reproduce here not in the interest of retailing The Economist’s take on what they say, but to tell you what they really say. Because these charts, and the studies which they encapsulate, should speak volumes to advisors and their clients about the realities of investment "performance" – and even more about investor performance.

As you see, the first chart (a product of the Bogle Financial Center and Lipper, Inc.) studied the performance of 851 U.S. equity mutual funds which had assets over $100 million at year-end 1996. It ranked all these funds for two four-year periods: 1996 through 1999, and 1999 through 2002.

Now, it’s one thing to say – as our compliance officers ritually do – that past performance is no guarantee of future results. It’s another thing to make the dry (though intellectually rigorous) observation that there is no statistical evidence for the persistence of performance. But the very nearly perfect inverse correlation delineated in this chart transcends any intellectual verities: it should make a good advisor’s heart sing.

For, as you see, of the top 10 funds (out of 851) for 1996-99, none finished higher than 790th in the second period. Indeed, the number nine finisher in the earlier block of time was the absolute worst (851st) performer in the latter. Finally, all 10 top funds from 1996-99 produced negative returns in 1999-2002, roughly in the range of -25% to -50%. (And how many of those top 10 funds do you suppose went into the second period carrying four- and five-star ratings from you-know-who? My guess is: all of ‘em.)

This may be intuitively obvious to you. (After all, how else would one achieve the most spectacular gains in a wild bull market other than by risking the most principal?) But I guarantee you that it is still anything but intuitive to the American investor. And I believe that no client or prospect of yours should be safe from learning these data.

In the second chart (whose sources are given by The Economist as DALBAR and the Bogle Financial Center), what starts out as an argument for indexing turns into the most powerful statistical argument for professional (behavioral) advice I ever saw, or expect to see.

Between 1984 and 2002, says DALBAR, the Standard & Poor’s 500 stock index returned 12.9% a year. Bogle calculates that during this period the average equity fund returned 9.6%.

So far, so bad. I would argue that, say, 2.3% of that 3.3% shortfall is, for better or worse, systemic – in that it probably costs something in the neighborhood of 1.3% to run any actively managed equity fund, with another 1% going to the advisor. And Bogle, if he had the sense to leave the issue binary, would (a) pointedly ask me to account for the last 1% of the shortfall and (b) aver that no one can consistently identify funds whose managers can consistently overcome my systemic 2.3 (or whatever) percent. But he doesn’t leave it there.

He takes one more statistical step, and in doing so blows the whole indexing/active management issue into irrelevance. Because, as you see, he calculates that during this period the average equity mutual fund investor got an annual return of only 2.7%.

(Forgive a boring digression, but I don’t seem able to stop myself: In reality, no one can actually calculate the return of the average investor, but only the return of the average invested dollar. Bogle’s assumption is that they amount to the same thing. And this may even be true.)

What this demonstrates is that the governing variable in mutual fund returns to real people in real life isn’t cost, or active/passive, or anything but wildly inappropriate investor behavior (chasing the hot dot; panic; excessive switching, etc.).

If all an advisor were ever able to do – and heaven knows it isn’t – were to close the gap between the average investor return and the average fund return (through effective behavioral coaching), the investor’s return in the period under discussion would have been more than 350% better.

Even if that meant leaving the other 3.3% on the table – which it doesn’t, not least of all because an index fund costs 30 or so basis points to operate – something like three quarters of the gap between the index and the average investor would have closed. (Or, if you prefer, the advisor’s one percent fee would have netted the average investor a 6.9% incremental return: the difference between 9.6% for the average fund and 2.7% for the average investor.)

Once and for all: investors don’t get investment returns. They get investor returns, which are orders of magnitude worse, unless and until they hire a professional behavioral advisor.

Be that advisor.