At Springwater, we believe that the best strategy for generating superior long-term investment results is to focus on setting the appropriate asset allocation (or mix of categories of investments, like large cap stocks, small cap value stocks, real estate, bonds, etc) and then implementing that allocation in the most cost-effective and tax-efficient manner. For us, this means using institutional class, no-load mutual funds, and ETFs (exchange-traded funds).
But the allure of active management – of finding an advisor, fund manager or zen master – who can consistently identify the best investments, and avoid the under-performers – is powerful. This allure is supported by millions of advertising dollars spent by the financial services industry, in an effort to convince investors that they have the best crystal ball.
Our argument in favor of asset allocation over active management is based in part on reams of historical data that show most active managers consistently under-performing their benchmarks.
The New York Times published an article on July 19, 2014 that reviewed a recent Standard & Poors/Dow Jones Indices study. The S&P/DJ study looked at the performance of over 2,800 actively managed mutual funds for the 12 months ending March 2010. They selected the top quartile, or 25%, of the funds, and then tracked their performance over the subsequent four 12-month periods. How many of the over 700 funds remained in the top 25% for five consecutive years? Two. That is exactly 0.27%.
What’s the conclusion? According to S&P/DJ’s senior research director: “It is very difficult for active fund managers to consistently outperform their peers and remain in the top quartile of performance over long periods of time. There is no evidence that a fund that outperforms in one period, or even over several consecutive periods, has any greater likelihood than other funds of outperforming in the future.”
Active manager out-performance is so inconsistent as to make distinguishing luck from skill effectively impossible.
What’s the implication? As the Times’ author points out: This seems to bolster the case for index-fund investing. After all, if a fund manager with a great year can’t be counted on to outperform other fund managers later, it’s reasonable to ask: Why bother trying to beat the market at all?
We couldn’t have said it better ourselves!
You can read the entire New York Times article here.