When Stock Pickers for Mutual Funds Stop Picking Stocks

Picking stocks has become so hard that some mutual fund stock pickers have given up pretending to try.

Pry open the hood of a mutual fund, and you might be startled by what you find. In the past, you would have seen roughly 100 stocks, each painstakingly selected by a portfolio manager passionate about beating the market. Today, you’re increasingly likely to find a few handfuls of exchange-traded funds — those autopilot portfolios that seek to mimic the market rather than beat it.

This evolution in how mutual funds are being run changes the relationship between funds and their investors. Some folks might respect the intellectual honesty of a money manager who has climbed off the hamster wheel of trying to beat the market. Other investors might feel they aren’t getting their money’s worth if they’re paying for active management but their fund manager largely picks other funds instead of individual stocks.

This lack of expertise by fund manager's is even worse when you look at the success of mutual funds. I have often advised that index funds are better than actively managed funds. This advice is even more prudent if the actively managed fund is really an index fund in sheep's clothing.

SPIVA tries to compare actively managed funds compared to their benchmark such as large company actively managed funds compared to large company index funds. The mid-year 2015 results showed little improvement in actively managed funds. For instance:

  • The first half of 2015 witnessed modest fluctuations in the domestic equity market. Based on the June 30, 2015, SPIVA U.S. Scorecard data, 65.34% of
    large-cap managers underperformed the benchmark (S&P 500, 7.42%) during the past one-year period. The figure is equally unfavorable when viewed over longer-term investment horizons. Over the five- and 10-year investment horizons, 80.8% and 79.59% of large-cap managers, respectively, failed to deliver incremental returns over the benchmark.
  • The investment landscape improved modestly for mid-cap managers, with roughly 48.21% failing to beat the S&P MidCap 400 over the one-year period. Despite a modest decrease in the percentage of small-cap managers underperforming the benchmark, 58.52% of active small-cap funds still lagged the benchmark.
  • However, over the longer-term horizons, such as the five- and 10-year periods, an overwhelming majority of actively managed mid- and small-cap funds underperformed their respective benchmarks.
  • It is commonly believed that active management works best in inefficient markets, such as small-cap or emerging markets. This argument is disputed by the findings of this SPIVA mid-year 2015 report. The majority of small-cap active managers consistently underperformed the benchmark in both the 10-year period and each rolling five-year period since 2002.

While I believe that an individual investor can pick great companies to invest in. I do not believe that their portfolio should be assisted with actively managed funds. Instead simply pay the lower cost of an index fund and diversify about 35-40% of your portfolio evenly between large cap, small cap, international and bond index funds. The remaining 60-65% of your portfolio should be targeted at high quality growth companies like those I list on my Watch List. Those high quality growth companies should then be invested in with the techniques that I teach in my book, The Confident Investor. You can purchase my book wherever books are sold such as Amazon, Barnes and Noble, and Books A Million. It is available in e-book formats for Nook, Kindle, and iPad.

Further reading: When Stock Pickers Stop Picking Stocks - MoneyBeat - WSJ

Also, check out this video explaining SPIVA:

https://www.youtube.com/watch?v=llGiz8t_f5U

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