July was a bright spot for mutual fund managers who insist that stock picking is the way to make money. Sixty-seven percent of large-cap stock pickers beat their benchmarks while small-cap managers did their best so far this year, with 43% of them beating their index.
Deal me in, right? Except that those July numbers were outliers, the exception that proves the rule. Overall, active managers have turned in an awful year, with just one in five (22%) of large-cap managers outpeforming the indexes to date.
That result is only because of a good July. Subtract the turnaround month and just 14% of them beat.
In simple terms, the chance that your fund is a winner so far this year is slim indeed. By the time you move money out of that loser and into one of the better-performing funds, assuming you can, that fund is likely to go south, too.
What’s more, over longer stretches of time a one-in-five “beat” track record is about normal. The SPIVA Institutional Scorecard found that over five-year periods large-cap funds had about a 24% chance of beating their indexes, while small cap managers did so about 20% of the time.
Another way of saying it: Between 75% and 80% of the time, active fund managers blow it, and usually because of their fees.
I know the first half of this column is full of numbers. But here’s the takeaway: More than numbers, your emotions matter to outcomes. That’s why passive investing is so powerful.
Put yourself in the shoes of the active fund manager right about now. He’s just posted results worth bragging about — finally. He’s got a chance to talk up his good picks and to justify the stiff fees he charges investors in his fund.
In the back of the manager’s mind, however, he’s quivering in fear. The next month could easily erase the gains of the previous month.
After all, the average large-cap fund in July returned 4% while the Russell 1000 benchmark returned 3.8%. It’s a win, but just barely.
Stock pickers panic
More importantly, that active manager now has to make bigger and riskier bets to pull ahead for the year. Strategies that should be rock solid are second guessed. Stocks with promise will be given no room to fail.
Every year as December rolls around active fund managers clean house. They unwind holdings and dump stocks left and right. The hunt for return becomes frantic.
The managers know that their investors will be opening statements in January. If the numbers don’t hold up against the stock market index, redemption requests will roll in like a tide.
Thousands upon thousands of investors every year bail out of a relative “losing” fund and put cash instead in the small percentage of relative “winning” funds.
And the cycle begins anew, with some funds smothered out of existence and others rolling in new cash from investors due to a mere accident of timing. Soon enough, they’ll be losers, too.
Meanwhile, the indexes roll on, unperturbed, year after year.