No Logical Reason for Active Management

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“The conclusion is inescapable: Active managers as a group, simply don’t add value…In short, there is truly no reason for a self-directed investor to own actively managed funds over index funds. Just as someone who stays at the roulette wheel long enough will feel the pain of the green house numbers, so too will investors in active funds find themselves in the hole over time.”

These are the words of Daniel Putnam1, a contributing author to InvestorPlace who wrote an excellent article titled “The Gruesome Truth about Actively Managed Mutual Funds”. Putnam compares active management to baseball in that both endeavors allow for a 70% failure rate. As with many articles that we have published, Putnam summarizes the results2 of the Standard and Poor’s Index Versus Active Scorecard (SPIVA®). Putnam points out that out of the 35 categories that SPIVA tracks, actively managed funds outperformed their benchmarks in only three of them. Beyond those three narrowly defined categories, Putnam characterizes the performance of active funds as “beyond abysmal”, noting that a full 73% of funds lagged their benchmarks over the five-year period ending 6/30/2013.

One thing that we found quite interesting about this article is Putnam’s biographical paragraph where he is described as having traded stocks and options successfully for more than 15 years. Assuming that is indeed the case, then he is someone who could easily be advocating for active management, yet clearly he is not. Perhaps he realizes that if he has been truly successful at trading stocks and options, then he is in a very small minority, and he has been playing a game where the playing field is about as level as a roller-coaster.

Putnam closes his article with an anecdote that we are compelled to repeat:

Earlier this year, I was interviewing a manager of a domestic equity fund who had underperformed across all time periods. I asked him, “If a potential client asked you why he or she would buy this fund, what would you say given its track record?”

He paused for a moment, and replied, “Honestly? There’s no logical reason why someone should buy this fund.”

Of course, there might be an illogical reason for someone to buy that fund such as, “Hope springs eternal.” But as Rudy Giuliani said, “Hope is not a strategy.”