The Wall Street Journal recently ran a story implying that actively managed funds – where stock picking strategies are employed – are on the “Comeback Trail”. See chart:
While that may be true, relative to prior years, the unspoken message in the chart is that fewer than half of the actively managed funds produce superior returns vs. a comparable benchmark (e.g., S&P 500).
What’s also not shown here is that of the active managers who do beat the benchmark index in a given year, very few do so in the years that follow. This suggests a randomness or luck factor at play. However, these active managers charge high fees regardless of performance, and are often “closet indexers”, that is mostly mimicking the portfolio of their target benchmark index.
Over the past few years the flow of funds within the Mutual Fund and Exchange Traded Funds universe has been directed towards “passive” index funds which own all of the stocks in an index rather than trying to pick winners from the list. Vanguard was the pioneer in index based investing and is the largest asset manager in the world with over $4 Trillion in assets under management.
Investors have come around to understanding that lower costs and simply buying the index is a better more consistent way to invest. Passive funds not only carry lower operating expenses, but also have much lower transaction fees due to much lower portfolio turnover, as well as being more tax efficient.
That’s why Warren Buffett famously bet $1 million that a simple index fund would outperform a collection of expertly picked Hedge funds over a 10 year period. He’s about to win that bet.
There are those who buy and hold low-cost, diversified portfolios—and then there are those who generously contribute to Wall Street bonuses.
Costs matter and chasing the latest hot performing fund is a sure way to see your portfolio under-perform.