For those who are movie buffs, you will recognize the title of this blog from “Field of Dreams”. The phrase refers to 1919 Chicago White Sox, who unfortunately became known as the Chicago Black Sox. Many players on the Chicago team were accused of taking money from bookmakers to throw the World Series and were banned from baseball.
In the movie, when a little boy was talking with a Chicago player that he looked up to, “Shoeless” Joe Jackson, he said, “Say it ain’t so, Joe”. The news about someone whom the child had put on a pedestal was breaking the boy’s faith in baseball and he was hoping Joe would say the reports were not true.
How does this relate to a blog from an investment guy?
In my last blog, “Is Trying to Pick Active Managers a Loser’s Game?”, I mentioned this line and, as I was expecting, it has come in for some criticism.
It is hard for many to believe what the numbers show: that index funds outperform most actively managed strategies.
For many years, active management was the only game on Wall Street and managers with hot hands were, and still are, put on pedestals (see the link to Warren Buffett’s advice below). Many of us grew up in an investment world that was dominated by reports of star active portfolio managers. For me, moving beyond this has been particularly hard.
I spent the majority of my career successfully promoting and selling active management. I believed in it and was good at it, rising to be a Managing Director and receiving awards from the Chairman of my firm for record sales of active strategies. I have even written pieces on subjects such as how to find talented managers using tools such as Active Share (more on this in the future).
Sometimes I feel like the little guy in “Field of Dreams”.
I fundamentally believe that people who work harder should have an advantage and, even though I am now am convinced, a part of me still wants the answer to be different when research compares active managers to index funds.
As with many things, however, it is not all about working harder. You need to also work smarter, not let emotion get the better of you, and stay focused on solid evidence about what consistently works over long-term periods (please notice the use of the words long-term). In the world of investing, this has made me a believer in so-called evidence-based investing which, based on long-term evidence, is biased toward index strategies.
I could write much more about this but, versus presenting only my ideas, I encourage you to take a look at the evidence yourself.
At the end of this post, I have listed a few links to recent articles and research on this subject. You can find other pieces on our Fiduciary Wealth Partners Pinterest website, which we are experimenting with as a place to post articles. If you have others articles or research papers on this point, please let us know and, as always, we welcome data that gives the other side of an argument.
Charts often tell a story best, so I include the following table from a 12/31/14 comprehensive study done by S&P Dow Jones Indices. It illustrates the percentage of U.S. equity funds that underperformed their appropriate benchmark index (a link to the full report is at the end of this post).
In summary, the S&P Dow Jones Indices research reports that:
- Based on data as of Dec. 31, 2014, 86.44% of large-cap fund managers underperformed the benchmark over a one-year period. This figure is equally unfavorable when viewed over longer-term investment horizons. Over 5- and 10-year periods, respectively, 88.65% and 82.07% of large-cap managers failed to deliver incremental returns over the benchmark.
- The returns of 66.23% of mid-cap managers and 72.92% of small-cap managers lagged those of the S&P MidCap 400® and the S&P SmallCap 600®, respectively, on a one-year basis. Similar to the results in the large-cap space, the overwhelming majority of mid- and small-cap fund managers underperformed their benchmarks over the longer-term horizons as well.
- It is commonly believed that active management works best in inefficient environments, such as small-cap or emerging markets. This argument is disputed by the findings of this SPIVA Scorecard. The majority of small-cap active managers consistently has been underperforming the benchmark over the full 10-year period as well as each rolling 5-year period, with data starting in 2002.
- The lowest percentage of outperformance by active mangers has tended to occur in the best-performing asset classes. Among the nine U.S. style categories, mid-cap growth was the best-performing asset class over the past 10 years, with the S&P MidCap 400 Growth returning 10.03%. However, it is also the category where the highest percentages of managers (91.81%) have underperformed.
- International and emerging market equity indices posted negative returns in 2014. During the same period, the majority of the active managers investing in international, international small-cap, and emerging markets equities fared worse than their benchmark indices.
Say it ain’t so, Joe. Say it ain’t so.
Financial Times – Active Fund Management Is Not Fit For The Purpose
(this link might require a subscription to the FT)
Warren Buffett To His Heirs: Put My Estate In Index Funds
Warren Buffett’s Advice to LeBron James: Index Funds
(yes, Buffett, who is known to be focused on long-term evidence, is an index fan)
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