Any causal finance novice will be familiar with hedge funds, ETFs, and mutual funds. And if you asked people to compare these investment vehicles to motor vehicles, they’d probably say hedge funds are Lamborghinis, ETFs are utilitarian pickup trucks, and mutual funds are the aging Cadillacs that are eyesores on our roads.
These characterizations are actually quite wrong for several reasons. For one, many pension plans invest in hedge funds, and they demand stable and consistent performance more than they demand the massive outperformance hedge funds are famous for promising and often not delivering. Mutual funds are actually a varied bunch; some are passive investment vehicles, and some are serious outperformers steered by finance stars that are revered more than many hedge fund principles. And ETFs range from the highly utilitarian index funds (SPY, VTI) to risky leveraged trading instruments (VXX, UWT).
Plus there are additional types of funds these categories don’t consider. There are ETNs, closed-end funds, BDCs, REITs, and MLPs. Additionally, there are additional distinctions that are more important; a corporate income ETF and CEF will have more in common than a municipal bond ETF and a commodity-focused ETF.
When analyzing funds, it’s important to look at their overall strategy, their structure, their fund ratio, their management team, and their historical performance. Each of these will be of varying significant depending on the fund and your goal.
But let’s consider life inside these funds. Because each fund makes different demands on its fund managers, and working for each fund is a very different job.
Passive funds, whether an ETF or a mutual fund, are the lowest key from an employee’s perspective. They will involve minimal management and almost no oversight from analysts. Instead, the oversight is more based on accounting and legal considerations, managing payouts, processing paperwork, and so on. These are low-cost tasks, which is why their fees are the lowest out there, whether structured as a mutual fund, ETF, or something else.
Then there are the active funds. These involve more analysis from fund managers and more information from analysts. They involve careful quantitative study of correlations and trends as well as qualitative study of macroeconomic changes and new developments in businesses and sectors. These require numerical acumen, sound judgement, patience, and experience. They also cost more and often underperform. But the best of them outperform for a very long time and provide investors with access to exotic investment vehicles (MBS, corporate bonds, and so on) that they couldn’t get elsewhere.
Finally an additional consideration is at play with many of these funds, particularly annuities, BDCs, REITs, MLPs, and CEFs. Many of these attract investors because of the very high income that they pay. That usually means keeping a dividend payout ratio near 100% and trying to avoid a cash shortfall that results in forced selling of assets or a dividend cut, which can often cause funds’ values to plummet. This is a very hard job and involves a lot of math and careful stewardship of portfolios. Funds that can play this game well can offer massive returns to investors who choose them. They also can pay top-performing analysts and managers tremendous salaries for delivering high incomes and superior performance to investors.
There’s a reason why active funds and high-yielding funds charge more money. They involve more work and more unique skill. For new analysts who find themselves in these funds, they will find more challenges than mere stock picking and idea generation. Being aware of these unique challenges early can prepare potential analysts for success—and funds with a high qualified and top performing new star.