I have also noted that when picking an actively managed fund one is actually increasing risks relative to the index fund. With the actively managed fund the investor doesn't really know what he is buying, the holdings can differ significantly from the "style category" and description of the fund. A large value fund could own mostly growth stocks, a domestic stock fund could own a significant % of non US stocks etc.
For the above reason one runs the risk that the funds returns will differ significantly from the asset category. And a portfolio that may seem diversified not be, and one might "miss" capturing the returns of the asset category even though one thought it had exposute to that asset class.
Finally one has what I call "manager risk". In an index based portfolio one only has the exposure to the asset class and will capture its risk and return (beta for those so inclined). By using an active manager one is adding "alpha risk" a fancy way of saying the investor has taken a leap of faith that the manager will deliver better than market returns.
Much of this is often seen as relevant only to the quity portion of the portfolio. It is implicitly assumed that bonds are a sleepy part of active management and that active managers might add a bit to returns and if they don't the negative outcome will be minimal.
Nothing could be farther from the truth. Just as in the case of stocks a bond fund may hold types of bonds that would not be expected from the funds title. And actively managed total bond market funds can take very big bets in terms of maturities and types of securities.
Investors in Oppenheimer bond funds have certainly learned these lessons the hard way as reported in the trade publication Investment News my bolds
With the battered performance of its bond funds creating a financial nightmare for investors, OppenheimerFunds Inc. is fighting to rebuild its image...
The company's bond funds lost an average of 29% last year, compared with a 7.9% average decline for all bond mutual funds, according to Morningstar.
The firm is working diligently to "rebuild the trust advisers had in us for a number of years." The $1.11 billion Oppenheimer Core Bond Fund (OPIGX) was hit particularly hard, losing 37.6% last year. The benchmark index for the fund, the Lehman Brothers (now Barclay's Capital) Aggregate Bond Index, rose 5%.
A big reason for the poor performance was the bets that OppenheimerFunds managers made on commercial-mortgage-backed bonds — bets that were amplified because of the use of derivatives to attain leverage.
And apparently even an "expert" in choosing mutual funds missed the boat and didnt avoid Oppenheimer bond funds.
Despite assurances that OppenheimerFunds had addressed the issues that led its bond funds to implode, Adam Bold, chief executive of The Mutual Fund Store, said that it may still pull clients out of two recommended OppenheimerFunds bond funds.
“It's not just the performance problems,” he said. “My concerns are on the risk-management and corporate-governance side.”
The problems reach into 529 plans as well
In addition, Oregon Attorney General John Kroger filed a lawsuit against the company last month, seeking to recover $36.2 million that the state claims that investors in a Section 529 college savings plan lost because OppenheimerFunds' Core Bond Fund took “extreme risks in a search for speculative large returns” (InvestmentNews, May 4).
At least four other states — Illinois, Maine, New Mexico and Texas — are also looking into possible legal action.
The problems don't end there either:
Oppenheimer Funds also faces a spate of class actions related to various bond funds.
Actions have been filed related to losses incurred in the Oppenheimer California Municipal Fund (OPCAX)(-28.49 1 yr through apr 30) and the Oppenheimer Champion Income Fund (OPCHX)(-79.28 i yr throught apr 30). The lawsuits claim that the risks associated with investments in the funds weren't disclosed to investors.
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