the expenses associated with the management of an actual portfolio. The
fund returns used are net of fees, exclud- ing loads. Returns are based upon
equal-weighted fund counts. The data assumes reinvestment of income and
does not account for taxes or transaction costs. The risks associated with
stocks potentially include increased volatility (up and down movement in the
value of your assets) and loss of principal. Bonds are subject to risks, including interest rate risk which can decrease the value of a bond as interest
rates rise. Investing in foreign securities may involve certain additional risks,
including exchange rate fluctuations, less liquidity, greater volatility, different
financial and accounting standards and political instability. Past performance
is not a guarantee of future results.
While some managers were able to beat the market, this
raises the question: was it luck or skill?
Universe of Active Mutual Fund Managers 1975-2006
years now.
Their May 2009 Indices Versus Active Funds Study specifically
focuses on the bear market of 2008 and concludes that “the
belief that bear markets favor active management is a myth.”5
In the same study, Standard and Poor’s identified similar results
for the 2000 to 2002 bear market. In both that bear market and
the one in 2008, a majority of active funds underperformed their
respective S&P Index for all U.S. and international equity asset
classes. In aggregate in 2008, actively managed funds underperformed the S&P 500 Index by an average of 1.67%.6
One of the greatest challenges for active managers is the
extreme difficulty in forecasting the economy or accurately
predicting the market’s direction in advance. This makes it hard
for them to anticipate bear and bull markets.
In fact, Wall Street has a notoriously bad forecasting record: its
consensus forecast has failed to predict a single recession in
the last 30 years.7
.6% outperformed their
benchmark due to skill
In a 2008 research study3 — perhaps the most comprehensive ever performed — Professors Barras, Scaillet, and
Wermers used advanced statistical analysis, to evaluate the
performance of active mutual funds. They looked at fund performance over a 32-year period, from 1975-2006.
The study concluded that after expenses, only 0.6% (1 in
160) of active mutual fu nds actually outperformed the market
through the money manager’s skill.
This low number “can’t eliminate the possibility that the few
[funds] that did were merely false positives,” just lucky, in
other words, according to Professor Wermers.4
Threat 3: Few Active Mutual Funds Have Outperformed in
Bear Markets
Some have claimed that active managers have a distinct advantage in bear markets. They can get out of troubled stocks
and sectors early and avoid the worst of a downturn.
Standard and Poor’s has been measuring the performance of
active managers against their index counterparts for several
Looking back on the forecasts made for the markets at the
beginning of 2008, just before the greatest bear market since
the Great Depression, many of them turned out to be quite
optimistic.
At the end of 2007, Newsday gathered market predictions
from “eight major Wall Street Securities firms” and found an average price target for the S&P 500 by year-end 2008 of 1,653,
representing a 12% increase over 2007. And at the beginning of
2008, USA Today similarly surveyed nine Wall Street investment strategists. They were a little less optimistic, expecting an
average price target for the S&P 500 for the year of 1606, only
an 8.6% increase. Of course, we now know that the S&P 500
Index declined by 37% in 2008. And many of those major Wall
Street firms experienced their own unforeseen troubles, including being sold or merged.
If Wall Street experts can’t even predict recessions or the
direction of the market, it is questionable how active managers
can successfully pick individual stocks, in bear markets or bull
markets, especially since a stock’s performance is often very
sensitive to economic and market conditions.
Threat 4: Only a Few Stocks Have Generated
Strong Long-Term Returns Over The Last 20 Years
The performance of individual stocks differs greatly even though
stocks collectively have historically provided strong returns over
long investment horizons.
2
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