Following every major bear market, it seems that the active managers and market timers come out in full force.
"We got out of the market before the crash."
"Our sector rotation strategies allow us to remain nimble enough to avoid big losses."
"Buy and Hold is dead. Active trading is the only way to make money in this market."
It sure sounds attractive. After all, the markets have likely just delivered a major blow to your portfolio. Surely, someone out there must have been able to help me avoid the losses. And, of course, they will also be the same firm that will get me the upside of the market.
Well, I have good news. There are, indeed, funds that outperform the market averages. But here comes the bad news. Odds are likely that you won't pick the right ones. Or at least not at the right time.
Why do I say this? Two reasons:
- The study by Dalbar, Inc. that found that mutual fund investors typically experienced returns worse than the funds in which they invested due to poor timing of their investment dollars. The right time, by the way, is before they go on a run that beats the market, not after.
- The study by Standard & Poors (of S&P 500 fame) which compares the performance of actively managed mutual funds to the passive S&P indices.
It is the results of the second reason that I explore below.
Over the five year period ending December 31, 2008, the S&P 500 outperformed 71.9% of actively managed large cap U.S. funds. As I said earlier, there are funds that outperform the averages. However, you have a 28% chance of picking one of the winners, and a 71.9% chance that by trying to pick a winner, you wind up picking a loser.
Active managers will remind us that the large U.S. marketplace is the most efficient of markets. This means that there is less opportunity for astute active managers to beat the index. If they are right, we would expect to see a larger percentage of small cap active managers beat the index.
Of course, the academic community begs to differ. The academics maintain that it is more difficult to beat a passively managed index in the small cap markets due to the reduced trading inefficiencies. The larger number of companies and the higher cost to trade make it particularly difficult for an active manager to beat the small cap indices.
The results confirm the academic opinion. During this same five year period, 79.1% of actively managed mid cap U.S. funds underperformed the index. And right on cue, 85.5% of actively managed small cap U.S. funds failed to beat the S&P 600 Small Cap Index.
Similar results were also evident for International funds.
If you would like to read the entire report you can view the pdf on S&P's web site.
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