A 25% CHANCE OF SUCCESS
From The Economist Magazine, February 13, 2015
BETTING on red gives the punter an 18-in-37 chance (in Europe) or 18-in-38 chance (in America) of success in roulette. Parcel out your money carefully and you might have a diverting 20 minutes or so until it’s all gone, with a few wins along the way. If the odds were just one-in-four, then the whole game would be much more discouraging.
But those have been the chances, over the last 20 years, of largecap US mutual funds beating the market. It has happened in just five calendar years. In one sense, this is hardly surprising; professional fund managers own the bulk of stocks, so the average fund manager performance should match the index. But the index doesn’t have costs and the fund managers do. Those costs doom the fund managers to underperform. One does not have to believe in the efficient market hypothesis to understand this outcome.
But to the exent that any market is efficient, largecap US stocks is the one; dozens of analysts cover every stock and their business models are well known and understood. The chance that any investor has a unique insight into a particular company is very small.
Here are the figures from Morningstar for each of the last 20 years.
Year % of outperforming funds ave fund return S&P return
1995 11.2 31.4 37.6
1996 21.4 19.5 23.0
1997 9.8 26.1 33.4
1998 24.3 20.5 28.9
1999 43.7 22.1 21.0
2000 63.6 -3.6 -9.1
2001 42.6 -13.8 -11.9
2002 39.8 -23.3 -22.1
2003 38.2 28.0 28.7
2004 43.0 10.2 10.9
2005 58.6 6.2 4.9
2006 32.8 12.5 15.8
2007 55.0 7.5 5.5
2008 37.4 -38.6 -37.0
2009 59.4 30.0 26.5
2010 37.8 14.4 15.1
2011 18.7 -1.6 2.1
2012 36.8 14.9 16.0
2013 51.8 32.6 32.4
2014 13.4 10.3 13.7
Note that 2014 was actually the third worst year in terms of the proportion of funds that managed to outperform; fewer than one-in-seven managers did so. On average, active funds underperformed by around 1.6 percentage points a year, a big handicap for clients. There was one year, 1999, when most funds underperformed but the average return was slightly higher than the market. Still, the average return only beat the market 6 times out of 20. (To be fair, if one takes the average of each of the 20 years, active funds have outperformed 37% of the time. But that’s still very low.)
To those who would say that passive funds are also doomed to underperform the market after costs, that is true, but their costs are a lot lower. A shrewd gambler would consider them a much better bet.
Of course, many people will ignore this advice. They see an index fund as a boring commodity product; they want the best in class, a manager that can outperform. And no active manager will admit that he (or she) is likely to underperform. But it is remarkable how few will put their money where their mouth is.
http://www.economist.com/blogs/buttonwood/2015/02/mutual-fund-investing
I’m a department head for a high school in Toronto. I graduated from the Ivey School of Business at Western University and have been a DIY investor for over 20 years.