Dark Days

The Darkest of Days for Active Management

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Dark Days

“Active management has never been in worse repute—this is the darkest of days.”

                        --John Rekenthaler, Vice President of Research at Morningstar

This quote is from an excellent article in the Wall Street Journal by Jonathan Burton. Citing data from Morningstar, he notes that actively managed U.S. stock funds have suffered net redemptions of $70 billion year-to-date through 9/30/2014. Since overall flows into U.S. stock funds have been positive, we can infer that index mutual funds and exchange-traded funds (ETFs) have picked up the slack. In explaining this mass migration from active to passive, Burton cites the lack of performance, particularly during the 2008-9 market plunge. He quotes John Bogle, the founder of Vanguard, who says, “Investors got burned—they not going to make the same mistake.” Bogle also admonishes investors about ETFs when he says, “ETFs are fine, so long as you don’t trade them, but you’ll be tempted, usually at a bad time. They’re dangerous to your wealth.”

Burton brings in data from the S&P Dow Jones Indices Index vs. Active (SPIVA) Scorecard of 6/30/2014 showing that just 26% of domestic stock-fund managers were able to beat their benchmark over the last five years, which has been a very solid bull market. A paltry 13% of large-cap stock-fund managers managed to beat the S&P 500 Index. Prior SPIVA reports showed that most active managers in 2008 underperformed their benchmarks, demolishing the myth that “Seasoned professionals would shelter them from market storms by selling stocks and going to cash, thereby saving their portfolios.”

Since active management failed on both the bull and the bear side, there no longer remains a compelling reason for investors to stay with it. An individual investor (Cory Councilman) describes it as a loss of trust, and he goes on to beautifully summarize where disillusioned investors should go from here:

“I’m not interested in taking unnecessary risk and trying to beat the market. A couple of fund managers may be able to do it, but my ability to find those managers over the long period of time is going to be virtually impossible. If I can achieve a market return and lower my fees as much as possible, I’m going to be better off in the long term.”

Burton believes that individual investors are trailing institutional investors who “determined long ago that managers’ inconsistent results didn’t justify their higher fees, and pledged allegiance to lower-cost indexing.” One recent example comes from the $300 billion CalPERS fund, as noted in this Time magazine article. CalPERS can be thought of as the E.F. Hutton of pension funds (please see this YouTube video if E.F. Hutton doesn’t ring a bell with you). When they talk, other pension fund managers listen.

We at Index Fund Advisors are very pleased to see articles like this carried in a prestigious publication like the Wall Street Journal. The entire investment industry is now on notice that investors (both individual and institutional) have weighed active management and found it wanting. If you would like to learn more about investing in index funds to help you meet your financial goals, please call us at 888-643-3133.