Search for Winners: Skill, Hype, or Hope (Hint: go to Amazon for your fiction)
Mutual funds were first formed in 1924. Their original intent was to provide the investing public with broad access to the market. The idea was good at the time, despite a steep 8% commission cost, they were the only game in town for the investing public. As the market grew, researchers began to examine fund performance in search of skilled managers who could “beat the market.” However, they found with very rare exception, that if such skill does exist it’s lost to fees, taxes, and trading costs. Armed with these facts, knowledgeable, unbiased voices called for index fund creation to provide market access which would better serve investor interests. Yet it wasn’t until 1976 when the first index fund launched.
Despite clear evidence of index funds superior performance, it has taken a long time for them to gain traction. Index funds made up 45% of the assets under management (AUM) in equity funds and 26% for bond funds at the end of 2017, whereas both shares were less than 5% in 2005.1“The Shift from Active to Passive Investing: Potential Risks to Financial Stability?” The Federal Reserve Study, August 27, 2018 (revised June 20, 2020). Institutions (banks, insurance, and brokerage firms) dominate the market. These institutions sell more costly proprietary or affiliate investment products whose primary premise and pitch is we can “beat the market” or some catchy variant. It’s in their interest to promote the more profitable product line – at your expense.
This false premise drives the market beating sales hype. In 401k plans, high fee structures are often poorly disclosed and difficult to understand. Wall Street is very adept to exploit the uninformed with the hope of safety or high returns – all with hefty markups that reduce your profit. Moral of the story: buy your fiction at Amazon; buy facts for your portfolio and you’ll like the result much better.
Performance Studies & Commentaries: Chronology
1. 1933, 1944 – COWLES COMMISSION: CONSISTENT UNDERPERFORMANCE IN ALL 5 STUDIES.
2. 1951 – JOHN BOGLE’S THESIS: WINNING VS. LOSING (ODDS ARE 50-50 BEFORE EXPENSES).
3. 1952 – HARRY MARKOWITZ: DIVERSIFICATION & RISK-ADJUSTED RETURN MEASUREMENT.
Nobel prize economics 1990: optimizing risk-return in portfolio choices.
4. 1964 – WILLIAM SHARPE: ASSESSING ACTIVE MANAGEMENT VS. MARKET RETURNS.
Nobel prize economics 1990: pricing of financial assets via beta and CAPM.
5. 1965 – EUGENE FAMA: 1951-60 STUDY OF 39 FUNDS; 1984-2006 STUDY OF 3,156 FUNDS.
Nobel Prize Economics 2013: Efficient market theory of asset pricing.
6. 1965-67 – JACK TREYNOR/MICHAEL JENSEN: MEASURING INVESTMENT RISK.
7. 1973 – BURTON MALKIEL: “A RANDOM WALK DOWN WALL STREET.”
Active fund persistent underperformance.
8. 1975 – CHARLES ELLIS: “THE LOSER’S GAME” THE INDUSTRY AGAINST INVESTORS.
An industry insider’s candid confession
9. 1976 – BOGLE AGAIN: VANGUARD 500, THE FIRST INDEX FUND IS BORN.
Industry shifts messaging to “we can beat the market.”
10. 1997, 2002 – CARHART ET AL OUTPERFORMANCE IS TEMPORARY.
Results a function of driven expenses and survivor bias
11. 1996 – WARREN BUFFET: “SERIOUSLY, COSTS MATTER.”
“Most institutions and individuals are better served using low cost index funds.”
12. 2009 – VANGUARD 1985-2009 STUDY OF 260 FUNDS: BEAT 66% OF SURVIVORS
Only 136 survived
13. 2009 – VANGUARD 1985-2009 STUDY OF 260 FUNDS: BEAT 85% OF ALL FUNDS
If you include the 136 funds that didn’t survive, the index wins by even more.
14. 2009 – SWISS FAMILY INSTITUTE: 1975-2006 STUDY OF 2,076 FUNDS; LUCK!
25% outperformed and the outperformance attributed almost entirely to luck.
15. 2013 – WARREN BUFFET DIRECTS TRUSTEE: PUT 90% OF MY MONEY INTO INDEX FUND.
NOTE: Buffet makes this point repeatedly
16. 2019 – STANDARD & POOR’S (SPIVA), MORNINGSTAR, LIPPER STUDIES
SPIVA (S&P Indices vs. Active): index funds beat most active funds in every asset class, region, sector, and style; low expenses are the best predictor of future performance.2Russell Kinnel, “How Expense Ratios and Star Ratings Predict Success,” Morningstar Fund Investor, August 2010.
Jerry Matecun – Founder, President
Expert guidance to plan your future, preserve your lifestyle, and retire with confidence. For a confidential consult, contact me at firstname.lastname@example.org.
- 1“The Shift from Active to Passive Investing: Potential Risks to Financial Stability?” The Federal Reserve Study, August 27, 2018 (revised June 20, 2020).
- 2Russell Kinnel, “How Expense Ratios and Star Ratings Predict Success,” Morningstar Fund Investor, August 2010.
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