Managed Funds Take Beating Again From Indexes
According to a recent Standard & Poor's study comparing index funds to actively-managed funds for a five-year period ending in 2008:
Percent of actively-managed, large-cap fund managers who beat the S&P500: 28.1%
Percent of actively-managed, small-cap fund managers who beat the S&P SmallCap 600: 14.5%
Percent of actively-managed, emerging markets fund managers who beat the S&P/IFC Emerging Markets Index: 10.2%
Source: Wall Street Journal via Greg Mankiw
See previous CD posts on index investing here, here, here and here.
14 Comments:
This shows just how hard it is to manage a lot of money when you have to achieve good rates of return, be "diversified", while still being liquid enough to cover your payouts.
To me, buying an index fund is kind of like playing craps, only you're betting on everything. Wealth is completely relative. If we all invested in an index fund and earned 10% we'd all have the same wealth as before. It doesn't really matter what the return is as long as you are doing better than everyone else.
The people making real money aren't invested in mutual funds or index funds. Those people know what they are investing in and have better information and control over timing their moves than the retail investor. The retail investor has a very limited upside, but nearly unlimited downside. I really hate being a retail investor...
The one thing hardly ever mentioned is - thanks to their expense ratios and trading expenses - index funds RARELY beat the indexes they track. If they ever do, it ain't by much.
On the other hand, when active managers beat their index, they can beat it by quite a lot. Those outsized gains can help carry them ahead of the indexes during any subsequent time period(s) in which they might underperform. There are plenty of actively-managed funds that have done just that.
I'm not saying managed funds are better than index funds or vice-versa. Just wanted to offer a different perspective and some food for thought...
Patrick represents the "zero sum" school of economics -- except it's the RELATIVE zero sum school. Wealth is NOT "completely relative." Wealth increases when you (an individual, city, country -- whatever) is/are better off than before -- a time line analysis. Is our current society wealthier than past societies? By any objective standard, the answer is clearly "yes."
Patrick's "envy economics" makes Cuba look good, because everyone is proudly equally poor -- and arguably getting poorer. (Of course, in the "real" Cuba, some are more equal than others.)
I prefer a society where most are better off over time. Such a trend constitutes an increase in most people's wealth -- or at least in their standard of living. To think otherwise is to drink the poison being dispensed by the stimulus stupidos.
Anonymous makes the obvious observation that to beat a stock index (using the stock market), the only mutual fund that can do so is a managed fund. You end up with a bell shaped curve of performance. But "the house" has an edge -- management costs.
Hence we end up with a skewed bell shaped curve, with the high point still below the average index fund. To buy managed funds is like going to the casino and figuring to beat the house odds (beat the index performance) without being an "advantage player".
Index funds can come with VERY low management fees. Mine charge a total fee of 0.1% a year. A managed fund charges an average of maybe .75% a year -- probably higher. Those are tough house odds to beat.
If you insist on a managed fund, look at the Congressional Effect Fund. I've mentioned them here before. The historical record is stunning. Check out this gonzo strategy -- investing ONLY when Congress is not in session.
http://congressionaleffect.com/
Interesting that people can be shown the facts and still insist on active management. As an indexer for almost 20 years, I just know that I will propbably outpace 95% of investors on an after-tax basis.
In addition, I don't think S&P's study takes into account survivorship bias in mutual fund performance. This would have made the performance of active funds even worse ... if that's possible.
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Richard,
You're confusing technological progress with wealth growth. Things get better because we discover new technology that makes our lives better and market forces eventually make that technology available to people who could previously not afford it. That's improving the standard of living and I'm all for that.
I'm not really talking about envy economics either, it really doesn't have anything to do with envy or happiness. What is wealth? In our era it is money, in earlier times it was property and nobility. Going even earlier, it comes down to how many cows or goats you had. Wealth is simply a measure of your power.
All I was trying to say in the previous post was that "beating" managed funds by investing in an index fund is kind of a false gain. The real measure of gain/loss is what power your money (wealth) has at the end of the day relative to everyone else.
I have two actively managed funds I would like to mention for the last two years. They are Dodge and Cox Stock Fund and PIMCO Total Return. I have read studies on index funds for the last five years and concluded that index funds were slow to rebalance. The S&P 500 is run by committee who weigh growth in capitalization and then balnce.
Starting in 2000 the Tech Bubble began to pop and the S&P began to shrink with losses of 9%, 12% and 22.15% annually for 2000, 2001 and 2002. Dodge and Cox Stock (a value fund) grew by 10.3%, 9.33% and 10.54% for the same years. My thinking was a good actively managed fund gets out sooner in bubble type environments then the slow index fund.
For the year 2008 the S&P lost 38.04% and Dodge and Cox lost 45.2%. The S&P was heavy into financials and the value funds bought financial like Lehman and WaMu at bargain prices and large positions. They were both wrong and lost big-time. Oh well, I am going to stay with actively managed and luckily I had a large position (for me) in PIMCO Total Return which returned 3.94% for the last year and 6.44 for the last 10 years.
I think I will look for mutual funds and ETFs that emphasize growth of dividends. Any ideas out there?
gettingrational,
If it's dividends you want check out Master Limited Partnerships (MLPs). They aren't mutual funds, and I believe the laws keep mutual funds from purchasing them. However, they have killer yields and offer some nice tax-deferred gains. The only catch is you have to watch your state by state earnings for each state they operate in, and if you trigger that particular state's filing conditions then you have to file taxes in that state.
These companies (Kinder Morgan, Williams, TC Pipelines)don't pay corporate tax so they can pass through a lot of money to the unitholders. Fortunately, you rarely have to pay tax until you sell because they have tons of depreciable assets with which to offset income. It's a pretty cool setup and one I think more people should investigate. I think the potential state tax liability scares away a lot of people.
Patrick, thanks I will check out the MLPs.
This article has alot of truth to it and as a financial advisor for the retail client I have to be very much aware of this. I use Index funds and managed funds, but when I use managed funds, I use them based on the performance of the manager. Believe it or not, there are a few managers out there who do better than the index. ITHAX has outperformed by more than 10% in the last 10yrs (compared to the SPY). I just think people need to do their research and buy a mix of both based upon their long term financial goals. If you are in this for the short term you should not buy managed funds at all.
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