Nobody can deny a simple empirical fact: higher fees are associated with lower returns, on average (Here is a great paper by Ken French on the costs of active investing). This finding, logically, leads investors to focus on low-cost solutions as opposed to high-cost solutions, all else equal.
But do the rules apply to large professional investors?
As the story goes, the large endowments and pensions have an edge due to their scale and access to talent. David Swensen is the classic example. The Swensen story concludes that some large institutional investors should not invest in passive low-cost solutions because they’d be missing out on the “opportunities” that scale and access can provide. Great story, and Swensen is a wonderful anecdote of this working in practice, but the plural of anecdote is data. And what does the data say?
The study outlines fees and investment returns for state pension funds. The study concludes that states with the highest fees, as a percent of assets, had the lowest returns. The study shows a passive index mimicking state fund asset allocations provides higher returns. Private equity funds and hedge funds in which the states invested under performed relevant benchmark returns. The study provides some rationales for why the situation continues even though it costs states billions each year in foregone income.
After serving as a Captain in the United States Marine Corps, Dr. Gray earned an MBA and a PhD in finance from the University of Chicago where he studied under Nobel Prize Winner Eugene Fama. Next, Wes took an academic job in his wife’s hometown of Philadelphia and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management firm dedicated to an impact mission of empowering investors through education. He is a contributor to multiple industry publications and regularly speaks to professional investor groups across the country. Wes has published multiple academic papers and four books, including Embedded (Naval Institute Press, 2009), Quantitative Value (Wiley, 2012), DIY Financial Advisor (Wiley, 2015), and Quantitative Momentum (Wiley, 2016).
Dr. Gray currently resides in Palmas Del Mar Puerto Rico with his wife and three children. He recently finished the Leadville 100 ultramarathon race and promises to make better life decisions in the future.
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