posted on:  9/7/2006    revised: 3/10/2010

I read a quote from a financial planner saying "People would use EFTs more if they understood them better".  Separately - as a completely unrelated issue - I have been thinking that people would use hedge funds less if they understood them better and that perhaps I should write more on this topic.  Yet hedge funds are one of the great success stories of the financial services field while EFTs remain relatively obscure.  Although these investments are completely unrelated, when considered side-by-side the contrast revealed shows us an important lesson.

Let's take a step back to look at the fundamentals:

Exchange traded funds are widely viewed as a great resource to investors.  Perhaps the greatest invention for smaller investors since mutual funds themselves.  Virtually all professional financial advisers commend them and use them.  There are few if any negatives when used properly.  No investor has ever been burned by using an EFT (as opposed to some other investment choice in the same market).  EFTs are not in the "scandal sheet" in the evening news.  EFTs have performed "as promised" without headline-grabbing deviations.  Investment returns have been solid and consistent.

Hedge funds are basically unregulated mutual funds sold with extra hype.  Hardly a week goes by without another story of a hedge fund going bust or a manager accused of improper actions.  Thousands, perhaps tens of thousands of investors have been burned - (meaning that they would have done better choosing almost any other type of investment).  They are perhaps the most expensive type of investment one can own (except perhaps if you call insurance an investment).  Investment returns (as a group) are unimpressive, although a few lucky high performing headliners grab public attention.  Perhaps most amazing is that regulators cannot seem to find a way to effectively deal with hedge funds.  After all, this is a free country and as long as one is not violating the law...

So why this contrast?

My conclusion is that the sales process is still far more important than economists and accountants like to admit.  EFTs are just boring - no great story, no glitz; no incentive to sell the sizzle.  Just plain solid fundamentals.  Perhaps most important, nobody makes money promoting EFTs!

In contrast hedge funds are sexy - with flamboyant high profile personalities, huge fees and commissions that attract the best sales agents, and wonderful stories behind the investment that inspire and motivate us.  Every stockbroker knows that investors love a good story. 

In the short term, the story wins out over the fundamentals.  We will have to wait to see what happens over the long term.

keywords:   exchange traded funds, EFT, hedge funds, returns, regulation

related topics:

Copyright 2010 by Tony Novak. Originally produced and published for the "AskTony" column syndication prior to 2007. Edited and independently republished by the author in March 2010. All rights reserved.