We’re all familiar with the stereotype that investment bankers are overpaid purveyors of puffery and nonsense, whose rewards rise every time they help someone like Mitt Romney close a factory, or raid a steel workers’ pension fund. Increasingly however the interrogation lamps are turning to fund managers as the new face of financial evil. As the narrative goes, we will be bereft in our senior years because the greedy bums we’ve hired to invest our nest eggs are siphoning off way too much in fees. The solution is that we all pile into exchange traded funds (ETFs). Why pay some self-satisfied geek to spout jargon about beta or long-short strategies or value investing? The fees are much cheaper at passive funds, like ETFs, which simply rely on software that automatically buys and sells assets to track the movements in an underlying index. If we all just switched our nest eggs into ETFs, then these index funds wouldn’t work Technically, however, this is parasitical behaviour. And a parasite needs a host. Say what you will about the active fund management industry, at the end of the day someone needs to do the work of combing through financial reports, comparing the revenues and profits of Company A and Company B, examining management strategy and forecasting future demand. The world would be a lot less transparent - we’d know much less about what the evil corporations were doing – if there wasn’t an industry whose function is to examine the financial statements of publicly listed firms. No doubt it is efficient to have a certain percentage of assets under management hitch a free ride. ETFs drive down overall costs and put more pressure on traditional fund managers to prove their worth – i.e., outperform the broad market. Hong Kong’s Mandatory Provident Fund scheme plans to launch a “core fund” option with lower fees, which will almost certainly introduce passive funds to the MPF. One of the “most-emailed” New York Times stories earlier this month was headlined “Americans Aren’t Saving Enough for Retirement, but One Change Could Help”. That “One Change”? A switch out of “costly” actively managed funds to passive funds; the article cited cost analysis performed by Vanguard, the biggest tracker fund company out there. To say the obvious, if we all just switched our nest eggs into ETFs, then these index funds wouldn’t work. God bless, someone somewhere has to actually pay attention to the underlying fundamentals. Indeed, the growing love affair with ETFs exemplifies a certain “irrational cheapness” that has always plagued the savings industry. Individuals are averse to reaching into their pockets and paying up front for impartial financial advice. They want “free” advice and irrationally turn a blind eye to the commissions that they pay as a result. It is a short-term cheapness that raises costs over the long run. The result is a financial advisory structure which relies on commissions awarded for selling funds and assurance policies. Sometimes these commissions are quite chunky, at 5 per cent or more, and often the riskier funds offer agents the bigger commissions. Lehman mini-bonds? “Huge yield!” the agent says. If an adviser were paid upfront as a consultant, he might be more likely to say “huge ticking time-tomb” instead. Professional fund managers may suffer from the same myopia. They tend to pay for brokerage research in soft dollars – i.e., through trade execution. That seems like a rational swap, and it means money managers don’t have to dig into their pockets and hand over hard cash in return for research. But the practice might in fact raise costs in the long term, and create conflicts of interest. Fund managers being wined and dined by their brokers have a hard time seeing this, but for years some regulators in Europe have been pushing for an “unbundling” of commissions. Unbundling is just one possible way for active fund managers to cut fees. There are many others, and no doubt the competitive pressures put on the industry by ETFs will help spur creativity in cost-cutting. But the publicly traded corporate system relies on vigilance and sharp analysis – of which we need more, not less. It’s absurd to imagine the financial industry will be improved if we all hand our savings over to robots that blindly buy what’s going up, and sell what’s going down.