The debate about active vs. passive investment management will never end. This weekend‘s Wall Street Journal offers support for the active argument. In the article “The Return of the Market Beating Fund Manager” we learn that active stock fund managers may be able to beat the market with greater success than they have in the past.
The article suggests that active fund managers will benefit from a recent trend in which stocks are not as closely correlated as they have been recently. This should allow skilled managers to identify stocks which will outperform others.
In addition, there are some new tools which allow investors to find stock funds that will outperform their peers. “Active share” measures the percentage of fund assets that are invested differently from the fund’s benchmark. This could be helpful, because many large stock funds have become “closet index” funds which merely track their benchmark rather than attempt to beat it. A study by Antti Petajisto, a visiting assistant professor of finance at New York University’s Stern School of Business, found that one-third of U.S. stock funds essentially mimic their market benchmark. In contrast, the article argues, those funds with a high “active share” are more likely to beat the market. Professor Petajisto found that most active stock pickers beat their benchmark by 1.26 percent annually after fees.
I would very much like to review Professor Petajisto’s research. It is certainly not consistent with the data I have seen over the years on the success of active fund managers. Most fund managers underperform the market. There will always be some manager that beat the market. The problem is that we cannot know in advance who these managers will be. Furthermore, there is no way to know how long this market-beating performance will last.
Wouldn’t it be nice if we could identify the star fund managers in advance, stay in their funds until they lose their Midas touch and then jump out of their funds and into the next hot funds? Unfortunately, this is simply not possible.
The article also notes that actively managed U.S. stock funds have average expenses of 1.39% according to Morningstar, compared to 0.1% for inexpensive index funds. This is a big difference and active managers must beat it in order to outperform their benchmark. The reality is that very few of them do.
Active mutual fund management can produce results and funds likely to outperform can be identified! The underlying concept is that stock pickers make better decisions than other fund managers. The next step in the inquiry after the mutual funds likely to outperform should be to identify the stock pickers and track them. Would the concept be predictive and help to find the best funds in the future?
ReplyDeleteThere is another approach to this quest for funds likely to outperform available at www.FundReveal.com. The approach is different, but the underlying concept is similar: fund managers and organizations with good decision making processes will consistently make good decisions and produce superior investment returns. The FundRevealSM process analyzes objective historic performance of all 20,000+ funds available in the US. Our assertion is that analysis of risk and return performance relative to the market, represented by the S&P 500 index can identify those funds most likely to outperform in the future. The tool produces funds with persistent performance and provides a persistence rating. Backtesting simulation of the approach shows that a portfolio selected using FundRevealSM risk-return persistence analysis would outperform the S&P by 55% over the 5 years between 2005 and 2009. The analysis and a free trial of the tool are available at www.FundReveal.com.