Image Credit: Christophe Vorlet
By Jason Zweig | May 12, 2017 8:46 am ET
Propaganda dies hard.
Even as evidence continues to mount that stock pickers have underperformed the market averages, active managers insist that they will make a comeback. Analysts at Bank of America Merrill Lynch found earlier this month that 63% of active fund managers investing in large U.S. stocks outperformed their benchmarks in April, the best since February 2015.
Stock pickers claim that the rise of market-matching index funds, along with artificially low interest rates, have driven all stock prices up, making it unusually hard to pick winners. But active managers, they say, will prove their worth again when the market finally goes down.
Unfortunately, that isn’t what history shows. The odds of finding a stock picker who can do better in down markets have long been less than 50/50. The brief periods in which active managers did resoundingly better than the S&P 500 have tended to be times in which small stocks outperformed large. If you or your financial adviser think stock pickers will prevail in the next downturn, the evidence isn’t on your side.
I asked Rui Dai, an analyst at Wharton Research Data Services at the University of Pennsylvania, to analyze mutual-fund performance since 1962. That’s as far back as it’s possible to go with the comprehensive data on funds compiled by the Center for Research in Security Prices at the University of Chicago’s Booth School of Business.
Over that long sweep of time, Mr. Dai found, active managers didn’t do significantly better than the market when stocks went down. On average, he says, the odds of finding a manager who will preserve your capital in a falling market are “slightly worse than the flip of a coin.”
During the financial crisis, from late 2007 through early 2009, the S&P 500 lost 50.2%; the average U.S. stock mutual fund fell 49.7%. In the bear market of 2000-02, as internet stocks imploded, the S&P 500 lost 43.4%; the average fund lost 43.2%. But funds fell worse than the market in the sharp declines at the beginning of 2016 and in the summer of 2015.
All these numbers include the income from dividends as well as changes in price. The average of fund returns is weighted by size, with bigger portfolios counting more.
Stock picking does cost money. Since 1962, mutual funds have incurred an annual average of about 1% in expenses and probably at least as much in trading costs, reducing their net returns.
The S&P 500, a hypothetical bundle of stocks that you can’t invest in directly, doesn’t bear the burden of those costs. Index funds based on the S&P 500 do incur expenses, although at a tiny fraction of 1%, since these funds simply own the underlying basket of stocks without trying to pick winners — and trade only when a stock enters or leaves the index.
What about the good old days, when swashbuckling fund managers could do as they pleased? In the crash of 1973-74 — which, until the financial crisis, was the worst drop since the Great Depression — the S&P 500 lost 37.3%. Stock funds lost 38.9% on average, even though they had almost a tenth of their assets in cash at a time when interest rates exceeded 7%.
As far back as the 1920s, the investing public was led to believe that portfolio managers could work miracles. “Investment trusts,” like today’s closed-end funds, issued finite numbers of shares that could sell for more than the underlying value of their assets.
To evaluate such a fund, The Magazine of Wall Street wrote on Sept. 21, 1929, “a simple rule is to add 30 percent to 100 percent, or more, depending on upon one’s estimate of the management’s worth,” to the value of the portfolio’s net assets. In other words, the brainpower of the manager could make the fund worth much more than its underlying assets.
A few weeks later, stocks fell 12% in a day, on their way to shriveling more than 80% in the Great Depression. Index funds, which didn’t exist then, would have done just as badly. Active stock pickers did worse on average; many of their funds went bust.
For as long as there have been funds, there have been fund managers who — sometimes with skill, often with luck — have beaten the market, at least for a while. But they have always been hard to find, and their performance has typically been highly perishable.
If you want to protect yourself against a bear market, keep more of your money in cash and other assets unrelated to stocks. Don’t believe the propaganda that says you can count on a stock picker to provide your parachute.
Source: The Wall Street Journal, http://on.wsj.com/2psdcmN
Resources:
Definitions of ACTIVE, MUTUAL FUND, and PORTFOLIO MANAGER in The Devil’s Financial Dictionary
