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But in the presence of costs, the game becomes negative-sum. The index investor will achieve the market return with close to zero cost. Actively managed funds charge management fees of about 1% a year. Thus, as a group, actively managed funds must underperform index funds by their difference in costs. And empirical evidence suggests that active funds underperform index funds by approximately the difference in their costs. Moreover, actively managed funds tend to realize taxable capital gains each year. Passive index funds are more tax-efficient, making the after-tax gap even larger.
In 2016 investors pulled $340 billion out of actively managed funds and invested more than $500 billion in index funds. The same trends continued in 2017, and index funds now account for about 35% of total equity fund investments.
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Index funds have been of enormous benefit for individual investors. Competition has driven the cost of broad-based index funds nearly to zero. Individuals can now save for retirement far more efficiently than before by assembling a diversified portfolio of index funds. There is no better way to preserve and grow one’s savings.
The thing they don't talk about though is that most people don't invest in "average" actively managed funds. Most people invest their money in the better performing, lower cost actively managed funds, so the difference in returns isn't as big as it's made out to be.
But the even bigger problem is people behave badly, regardless of what they invest in. They tend to buy and sell funds too often, and they tend to buy high and sell low. Low cost index funds don't solve that problem.
yep , i have been in fidelity contra along with 115 billion in other investor money and we have been beating just buying an s&p index fund for years with less risk . .
investors tend to vote with their money and the better LONG TERM performing funds tend to get the lions share of investor money
I have Fidelity Contra in both my 401K and personal brokerage accounts; it's considered one of the better actively managed funds and is up somewhere around 18% this year. It didn't perform as well in 2016. I don't think one should never have an actively managed fund in their portfolio. It really depends, and looking at the performance over a 10 or 15 year span helps tell the tale. Also, most 401K plans don't have a straight "S&P500" type fund to choose. Some don't have anything equivalent to a total market fund either.
that is what these articles don't consider . managed funds may miss for years by a small amount but when they do beat things they beat it by a wider margin making up down the road .
in fact as you see with insight you can have a core of good funds but then use other funds that rarely beat their index through just the sweet spot of their weightings and then they are swapped .
the alpha gained by using non core funds dynamically adds performance to the portfolio without any of those funds excelling over the longer term .
it is all about the portfolio playing nice and supporting each other , it is not about how the sausage is made .
Of the choices I've selected in my 401K, the top 4 performing funds are split evenly between active and managed. The top 2 performing funds happen to be actively managed ones.
I always try to select passive funds in my 401K when possible and it makes sense to do so, but it's just a fact that some of the better performing funds (for this year) also happen to be actively managed funds and their performance is more than making up for the increased expense ratio.
So like everything in life.... it depends, and you have to take a closer look at the options you have available and the performance over 5/10/15 year spans of time.
The thing they don't talk about though is that most people don't invest in "average" actively managed funds. Most people invest their money in the better performing, lower cost actively managed funds, so the difference in returns isn't as big as it's made out to be.
The trick is to find a fund & manager who consistently outperform. There's been a lot of blood lost on that hill.
Here's one of the best of the best academic papers, but it is tough reading for the average investor.
The fact that the aggregate portfolio of wealth invested in active mutual funds shows no evidence of manager skill does not mean no fund managers have skill. It simply means that if there are good managers who produce positive α, they must be balanced by bad managers who produce negative α. Can we find evidence of good and bad managers?
The challenge in answering this question is distinguishing skill from luck. Even if no fund manager is good or bad, many funds will do well and many will do poorly purely by chance.
Insert a bunch of mathematical models contained in the post or in the academic paper it is based upon, and the answer is there are a bunch of funds that do more poorly than they should just by random chance. That is evidence that their managers stink like poop. That is, they have "negative skill." But what about the upside? The data suggest the existence of superior managers who, ignoring expenses, enhance expected returns relative to passive benchmarks. Once you account for expenses, only perhaps the top 1% to 3% of funds show evidence of skill that exceeds random luck.
In the chart above, the red line indicates the performance of funds if there were no skill at all -- just good luck and bad luck. The blue line indicates the actual performance of funds. Note that most everywhere the blue line is to the left -- meaning worse performance.
That's the evidence that most funds suffer from "negative skill". At the very top end you'll find the funds that exhibit skill.
Good luck finding them.
Last edited by SportyandMisty; 06-06-2017 at 06:02 PM..
I have Fidelity Contra in both my 401K and personal brokerage accounts; it's considered one of the better actively managed funds and is up somewhere around 18% this year. It didn't perform as well in 2016. I don't think one should never have an actively managed fund in their portfolio. It really depends, and looking at the performance over a 10 or 15 year span helps tell the tale. Also, most 401K plans don't have a straight "S&P500" type fund to choose. Some don't have anything equivalent to a total market fund either.
I agree with you. I am not an absolutist as far as actively managed funds go. I don't own it, but Fidelity Contrafund is a very good fund and it's been very good for a long time.
I am not sure about most plans, but I've seen a lot of plans that have S&P 500 or Total Stock Market index funds in them.
The fact that the aggregate portfolio of wealth invested in active mutual funds shows no evidence of manager skill does not mean no fund managers have skill. It simply means that if there are good managers who produce positive α, they must be balanced by bad managers who produce negative α. Can we find evidence of good and bad managers?
The challenge in answering this question is distinguishing skill from luck. Even if no fund manager is good or bad, many funds will do well and many will do poorly purely by chance.
Insert a bunch of mathematical models contained in the post or in the academic paper it is based upon, and the answer is there are a bunch of funds that do more poorly than they should just by random chance. That is evidence that their managers stink like poop. That is, they have "negative skill." But what about the upside? The data suggest the existence of superior managers who, ignoring expenses, enhance expected returns relative to passive benchmarks. Once you account for expenses, only perhaps the top 1% to 3% of funds show evidence of skill that exceeds random luck.
In the chart above, the red line indicates the performance of funds if there were no skill at all -- just good luck and bad luck. The blue line indicates the actual performance of funds. Note that most everywhere the blue line is to the left -- meaning worse performance.
That's the evidence that most funds suffer from "negative skill". At the very top end you'll find the funds that exhibit skill.
Good luck finding them.
Some fair points. I think just screening out the average or above average cost funds weeds out most of the bad funds. Actively managed funds with low expenses have a decent chance of beating the index.
I'm thinking of "A" or cheaper share classes of American Funds.
Dodge & Cox Funds (second cheapest after Vangaurd)
Several different Vanguard funds.
I have Fidelity Contra in both my 401K and personal brokerage accounts; it's considered one of the better actively managed funds and is up somewhere around 18% this year. It didn't perform as well in 2016. I don't think one should never have an actively managed fund in their portfolio. It really depends, and looking at the performance over a 10 or 15 year span helps tell the tale. Also, most 401K plans don't have a straight "S&P500" type fund to choose. Some don't have anything equivalent to a total market fund either.
What about the higher fees? How does that eat into the yield? Does it generate a lot of cap gains in your taxable account?
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