Alpha Power Investing Newsletter

October 16, 2009

Active Management No Help In Bear Markets

The historical evidence is clear and decisive, yet most investors behave as if it didn't exist. I'm talking about the evidence that active stock selection by so-called "experts" does not produce returns superior to the returns of a passive stock index. Indeed, the evidence is compelling that the average active portfolio manager costs his/her clients 2%-3% per year over the long-term compared to a comparable passive index benchmark.

In spite of the mountain of academic research supporting this position, most investors still believe that having an expert hand on the tiller will help them out when the going gets tough. Well, in 2008 the going got really tough and the experts' boats got swamped.

Standard and Poor's has recently released a report covering the returns of actively managed equity mutual funds in 2008, the worst year for stocks since 1931. The results of the survey simply confirm the data from the previous bear market of 2000-02; namely, that active management is a drag on performance (compared to index returns) even in down markets.

In 2008, the S&P 500 outperformed 54.3% of actively managed large-cap funds. The S&P MidCap 400 outperformed 74.7% of mid-cap funds, and the S&P SmallCap 600 outperformed 83.8% of actively managed small-cap funds.

The funds that did the worst compared to their index benchmark were growth funds in all categories. The S&P 500 Growth Index beat 90% of large-cap growth managers; the S&P MidCap 400 Growth Index beat 89% of comparable managers; and the S&P SmallCap 600 Index outperformed a whopping 95.5% of small-cap growth managers.

Investors who think that actively managed equity funds offer some downside protection are whistling in the wind. It simply isn't so.

Jerry Minton, Ph.D.

© 2009 Alpha Investment Research Inc.
Alpha Power Investing Newsletter Archives