American Flag

According to a recent report from Morningstar, 2011 was yet another banner year for the ascendancy of passive investing. Index mutual funds received net inflows of $76 billion, and exchange-traded funds which are primarily passive received $121 billion. Actively managed funds, however lost $9.4 billion in net outflows, and American Funds, one of active management’s largest proponents, lost an astounding $81 billion in net outflows which represents 9% of its total assets. American Funds has seen its total assets shrink from $1.2 trillion at the end of 2007 to $854 billion at the end of 2011. Its flagship fund, The Growth Fund of America, saw net outflows of $33 billion. At the end of 2010, Brightscope determined that it was the #1 mutual fund utilized in 401k plans. Unfortunately for these myriads of 401k plan participants, it lagged the S&P 500 by 7% in 2011 (source: Morningstar.com). Adding insult to injury, Brightscope’s #3 401k mutual fund, American Funds EuroPacific Growth Fund, lagged its benchmark by 1.4% (source: Morningstar.com).

For American’s bond funds, the picture does not get any prettier. According to Morningstar, all of them underperformed their benchmark over the last five years. Seeing how misery loves company, it is worth noting that Brightscope’s #2 401k mutual fund, the Pimco Total Return Fund, lagged its benchmark by 3.7% in 2011 (source: Morningstar.com).

Kent Thune of about.com does a wonderful job of articulating the advantages of index funds over actively managed funds—lower costs and the avoidance of “manager risk.” Index Funds Advisors, Inc. recently explored the question of whether or not there is a “manager risk premium”—i.e., can investors expect an additional return from engaging activity of manager-picking? The answer, of course, is no. As more and more investors become wise to the mug’s game of manager-picking, the companies that have staked their fortune to active management will continue to suffer.