The myth of actively managed mutual funds

In Michael Mauboussin’s book, “More Than You Know”, Mauboussin measured how many actively managed mutual funds successfully beat the S&P500 index. 

This is super-useful information for anyone trying to decide whether or not it makes sense to invest in index funds. Maybe you’ve heard (or maybe you haven’t) that popular opinion is that something like 80% of all actively managed mutual funds underperform their benchmark index. 

There’s a grain of truth to this… although the number isn’t 80%. 

Mauboussin found that in 1994, 1995, 1996, 1997, and 1998, this was — more or less — true. Actively managed funds underperformed the index. But in most years from 1991 to 2005, about 50% (and sometimes more) of actively managed funds beat the S&P500 index… meaning you’d have been much better off trying to find an active fund than relying on a passive index fund. You’d have earned more money if you were able to find the right fund manager.

Today? 

About a third of active mutual funds are “closet indexers”, meaning they built their portfolio to mimic an index fund. 

Most index funds try to match (as closely as possible), the makeup of a popular stock market index, like the S&P500. The goal with this type of investing is to emulate the performance of the Standard and Poors 11 sectors, as well the 156 sub-industries within those sectors.

And because index funds charge fees (however small), the end result is mostly going to be slightly less than the average return of the raw index. In other words, the essential nature or goal of index funds is to do slightly less than average. 

Personally, not a goal I would pursue, but hey… whatever floats your boat.

Anyway, point is, active funds do beat passive funds. That doesn’t mean everyon should chase actively managed mutual funds. There’s clearly a market for index fund investments. 

What bothers me is the mind-numbing narrative around “passive” investing. Investing is never passive, even when you’re in a “passive” strategy. With actively-managed investments, it takes a bit more time and research to find those stellar money managers… but… they’re out there. But, it’s easier to just say that they don’t exist because narrative. 

That’s not really a fair thing to tell folks who want to know what all their legitimate options are. 

If you want an actively managed investment, and you have a 50% chance of beating an index fund, then you really need to do some homework. Of course, even if you invest in an index fund, you still need to actively manage how your money is allocated over time because there have been long periods where the index didn’t go anywhere and sometimes… lost money.

No matter what you do, investing comes with some serious risks. Passive. Active. It’s all inherently speculative, although in very different ways.

David Lewis

This post brought to you by //The Rogue Agent//. David has been a life insurance agent, and worked with some of the oldest and most respected mutual life insurance companies in the U.S., since 2004. Learn more about him and his business, here.

This post brought to you by //The Rogue Agent//. David has been a life insurance agent, and worked with some of the oldest and most respected mutual life insurance companies in the U.S., since 2004. Learn more about him and his business, here.