Actively Managed Funds Underperform

by Alan Lavine and Gail Liberman

 Even if an actively managed mutual fund happens to outperform a passively managed fund, it’s difficult to predict which actively managed fund, if any, will repeat that performance.

That’s the upshot of a study that appeared in a recent issue of the Journal of Financial Planning.

Meanwhile, the number and percentage of individual actively managed funds that have outperformed the passive approach is low, the study indicates.

Thomas P. McGuigan, president of Beyond Tomorrow Strategic Advisors in Guilford, Conn., examined the 20-year performance of actively managed large company and mid-size company domestic stock funds.

He compared their performance with a passive strategy during the period of 1983 to 2003.

“The study shows that there is remarkable consistency in the relative performance of active versus passive strategies during ten-year periods,” he reported.

Some funds outperformed the index for shorter periods. For example, 55 percent of large-company funds did better than an index fund over five years. But the study did not consider the toll taken by sales charges, surrender charges, or advisory fees.

The bottom line: As the time period lengthens, it becomes more difficult for active managers to outperform the indexes. For 10-year periods, only one-quarter of the funds manage to outperform. Over 20 years, the percentage of funds that outperformed the index fund dropped to 10.59 percent.

Even considering that some funds did beat the index, the study found it nearly impossible for investors to predict which would be the future winning actively managed funds. Many of the funds that outperformed over 10 years failed to repeat their superior performance over the next 10 years.

In addition, the cost of picking wrong is high. McGuigan found that over 20-year period, the largest number of funds that managed to outperform the index fund did so only by 0 to 1 percent. Of 170 funds, only six managed to outperform by at least 1 percent.

You’d think that actively managed mid-size company funds would hold a greater opportunity for superior stock selection than large company stock funds. Not so. Those actually did worse against a mid-size company stock index than large company stock funds did against a large company stock index. Only 23.68 percent of mid-size company stock funds beat the index over five years, and a mere 2.63 percent outperformed over 20 years! 

Alan Lavine and Gail Liberman are husband-wife personal finance columnists, journalists and authors. They are the authors of "Rags To Retirement," published by Alpha Books. Their columns appear in newspapers throughout New England and the Southeast, as well as online. Their commentary on mutual funds and personal finance is carried by 200 radio stations nationwide every Sunday over Business News Network's Charles DeRose Financial Advisor Show. Al and Gail’s new book is "Rags To Retirement:  Stories from people who retired well on much less than you think," published by Alpha Books.

More articles by Al and Gail can be found here.