Indexing Fares Well Over the Long Term

Standard & Poor’s recently released its biannual study of mutual fund performance. S&P looks at the performance of actively-managed mutual funds versus appropriate stock market indices to see if the funds, as a group, added value for their investors.

Not surprisingly, actively-managed mutual funds fared poorly. The vast majority of them underperformed their benchmarks, showing that they have actually destroyed value for their clients. The table below shows the actual results. The odds of selecting a winning actively-managed mutual fund over the long-term are less than 8%.

 

% of Funds Underperforming

5-Year10-Year15 Year
Large-Cap88%85%92%
Medium-Cap90%96%95%
Small-Cap97%96%93%
Source: S&P Dow Jones Indices. Data as of 12/31/16.

 

It makes you wonder why anyone would pursue an active strategy if the odds of success are so low. We believe the answer lies with marketing and the “creative” way that the investment industry presents returns to investors. There are many regulations governing performance presentation, yet there is still ample room for the industry to put its best spin on things (or to put lipstick on the pig, as I prefer to say).

The weak performance by active funds is not because active money managers are not trying or lack intelligence. In fact, they are often some of the brightest minds on the planet. However, the investment industry is so competitive that it is hard for any manager to get an edge over others. Add to that the huge hurdle that management fees and investment costs pose, and the odds of outperformance become impossibly small.

More money is moving to index funds these days, as evidence like the S&P study pile on to the already large canon of evidence that indexing provides superior returns. However, active management will not be going away anytime soon. Just as large lobbying budgets can defeat common sense legislation, large marketing budgets can persuade plenty of investors that they should pay their money and spin the wheel. We prefer to stick with the evidence-based success of indexing.

To Download the complete 2017 Q1 Newsletter please click below.