Posted by on Nov 25, 2014 in Blog, Posts, Speaking |

By Jason Zweig

Image credit: Rembrandt van Rijn, “The Parable of the Rich Fool,” 1627.

Nov. 25, 2014, 11:04 p.m.


Ben Carlson’s recent tweet…

…prompted several people to ask me if I had the full text of my original speech. Here it is. It’s 17 years old, so treat it as you would any teenager, with a mix of firmness, caution, and respect.



Putting Investors First


Jason Zweig

May 1997

The Investment Company Institute (offsite)

Washington, DC



Who was the most important person in mutual-fund history?

In my mind there’s no question about it: His name was Edward G. Leffler, and he invented the open-end fund.  I’d be surprised if more than a handful of people in this room have ever heard of Ed Leffler—but he, more than any other single person, got us to where we are today.

Leffler started out selling aluminum pots and pans door-to-door after World War I, but he quickly saw that selling investments had a bit more potential.  And he saw that the existing world of closed-end funds, with their stagnant asset base, had to change.  In March, 1924, Leffler helped launch Massachusetts Investors Trust, the first open-end fund.  Its charter ensured, in Leffler’s words, that “investors could present their shares and receive liquidating values at any time.”

It’s hard to imagine that such dull words could contain so much dynamite.  But suddenly, a mutual fund could do something that was formerly unthinkable: it could grow.  It could survive a run of redemptions by replacing the departing shareholders with new ones.  It could raise cash from new investors to buy more stocks when they were cheap.  And it could spread its costs over a greater asset base, making it more profitable for the adviser to run the fund and  cheaper for investors to own it.

Of course, every great invention has the potential to change the world both for better and  for worse.  With nuclear power, we can treat cancer—or cause it.  With semiconductor chips, we can enlighten people with information—or suffocate them with it.  And Ed Leffler’s great invention has its dark side too.

Alfred Jaretski, a securities lawyer who helped draft the Investment Company Act, wrote in 1941:

 “As there is normally a constant liquidation by shareholders who for one reason or another desire to cash in on their shares, the open-end companies must engage in continuous selling of new shares of stock in order to replace the shares so withdrawn…. Under these circumstances, and with keen competition between companies in the sale of their shares, it [is] natural that some questionable practices should [develop].  It furthermore bec[o]me[s] extremely difficult, and in some instances impossible, for any one company or small group of companies to raise standards and at the same time compete with the others.”

Now listen to Larry Armel, head of Jones & Babson mutual funds, telling Fund Marketing Alert why his parent company has pushed Babson into selling through Charles Schwab and other fund supermarkets:

“We need to distribute the product in any legitimate way that makes sense, whereas five or ten years ago I would have said we have no interest in being a marketing firm.  We wanted to concentrate on the investment side and the investor.”

That’s where the newsletter article ends, but can’t you hear something hanging in the air? ”We wantED to concentrate on the investor.”  PAST TENSE.   Now, therefore, we must want to concentrate on something else.

And just this February, two portfolio managers, Suzanne Zak and Doug Platt, left IAI, a fund company based in Minneapolis.  As Suzanne Zak told the Wall Street Journal:  “It got to the point where I wanted to get back to the basics instead of being part of a marketing machine.”  And Doug Platt, whose father founded IAI, added:  “My father retired over 20 years ago, and the firm’s structure and focus are entirely different from what it was then.  IAI is basically a marketing company that happens to be selling investments.”

This is what I mean by the dark side of Ed Leffler’s invention.  Today, the question that you must decide as we face the future is crystal-clear:  Are you primarily a marketing firm, or are you primarily an investment firm?  You can be mostly one, or you can be mostly the other, but you cannot be both in equal measure.  Under the same roof these two objectives become, in Ambrose Bierce’s word, “incompossible.”

How do a marketing firm and an investment firm differ?  Let us count the ways:

  • The marketing firm has a mad scientists’ lab to “incubate” new funds and kill them if they don’t work.  The investment firm does not.
  • The marketing firm charges a flat management fee, no matter how large its funds grow, and it keeps its expenses unacceptably high.  The investment firm does not.
  • The marketing firm refuses to close its funds to new investors no matter how large and unwieldy they get.  The investment firm does not.
  • The marketing firm hypes the track records of its tiniest funds, even though it knows their returns will shrink as the funds grow.  The investment firm does not.
  • The marketing firm creates new funds because they will sell, rather than because they are good investments.  The investment firm does not.
  • The marketing firm promotes its bond funds on their yield, it flashes “NUMBER ONE” for some time period in all its stock fund ads, and it uses mountain charts as steep as the Alps in all its promotional material.  The investment firm does none of those things.
  • The marketing firm pays its portfolio managers on the basis not just of their investment performance but also the assets and cash flow of the funds.   The investment firm does not.
  • The marketing firm is eager for its existing customers to pay any price, and bear any burden, so that an infinite number of new customers can be rounded up through the so-called mutual fund supermarkets.  The investment firm sets limits.
  • The marketing firm does little or nothing to warn its clients that markets do not always go up, that past performance is almost meaningless, and that the markets are riskiest precisely when they seem to be the safest.  The investment firm tells its customers these things over and over and over again.
  • The marketing firm simply wants to git while the gittin’ is good.  The investment firm asks, “What would happen to every aspect of our operations if the markets fell by 67% tomorrow, and what would we do about it?  What plans do we need in place to survive it?”

Thus you must choose.  You can be mostly a marketing firm, or you can be mostly an investment firm.  But you cannot serve both masters at the same time.  Whatever you give to the one priority, you must take away from the other.

The fund industry is a fiduciary business; I recognize that that’s a two-part term.  Yes, you are fiduciaries; and yes, you also are businesses that seek to make and maximize profits.  And that’s as it should be.  In the long run, however, you cannot  survive as a business unless you are a fiduciary emphatically first.

In the short term, it pays off to be primarily a marketing firm, not an investment firm.  But in the long term, that’s no way to build a great business.  Today, tomorrow, and forever, the right question to ask yourselves is not “Will this sell?” but rather “Should we be selling this?”  I will praise every fund company that makes that choice based on what is right for its investors, because I believe that standard of judgment is the right standard.

Thank you.