News and Turtle2

A Look Back at Some Good Articles from 2014

News and Turtle2

At Index Fund Advisors, we consider 2014 to have been a tipping point year in the migration from active to passive management. Here are some of the articles that helped to convince us of this idea. Please enjoy.

Will Invest for Food (The Economist, 5/3/2014)

This insightful article compares the outlook for active managers with that of “newspapers, record labels, and taxi companies.” As the authors explain, “Earlier generations of investors were prepared to believe that the returns achieved by fund managers were down to skill. Now it has become clear that the returns were the result of factors that can be replicated.”  The days of packaging up luck and selling it as skill are over.

Who Routinely Trounces the Stock Market? Try 2 Out of 2,862 Funds (Jeff Sommer, New York Times, 7/19/2014)

Jeff Sommer presents the results of the Persistence Scorecard prepared by S&P Dow Jones Indices. The title pretty much tells the story of how only a miniscule number of active managers were consistently able to score in the top quartile of their peers in every year for a five year period. In this article, we dug a little deeper into the two funds that “routinely trounced” their peers and found that luck could not be ruled out as the explanation for their positive alpha. Note that from chance alone (or the assumption of perfect market efficiency), we expected to see three funds with this achievement, but we only actually saw two.

The Decline and Fall of Fund Managers (Jason Zweig, Wall Street Journal, 8/22/2014)

Jason Zweig summarizes a Financial Analysts Journal article by Charles Ellis which essentially declares the end of active fund management. As Ellis says, “The costs of active investment are so high and the incremental returns so low that, for clients, the money game is no longer a game worth playing.” The “game” that Ellis is referring to is what he called “the loser’s game” of active management. Zweig notes that index funds and comparable exchange-traded portfolios now account for 28% of fund assets, up from 9% in 2000. We see no reason for this trend to reverse in the coming years.

The Triumph of Index Funds (Bill Saporito, Time Magazine, 9/18/2014)

Bill Saporito notes two big decisions from the pension fund behemoth CalPERS. The first is its increased use of indexing at the expense of active fund managers, and the second is its abandonment of hedge funds. Saporito deemed these moves as a nod to Eugene Fama’s lifelong work on market efficiency. As CalPERS now states in its newly revised set of investment beliefs, “Markets aren’t perfectly efficient, but inefficiencies are difficult to exploit after costs.”

Investors Losing Faith in Active Fund Managers (Proinsias O'Mahony, The Irish Times, 1/21/2015)

While this article was published in 2015, it is focused on 2014 results such as the withdrawal of $92 billion from U.S.-domiciled active funds compared to inflows of $156 billion for passive funds. The author notes similar results in Europe where Vanguard's European stock index fund is now the continent's biggest equity fund, managing more than twice as much money as the biggest active fund in the region. The author also cites Lipper data showing that $17 billion was pulled from active funds in the U.K. in the face of 65% underperformance over the last decade. for European funds, the story is even bleaker with 80% underperformance. Lastly, the author cites Warren Buffett's announcement that he will utilize index funds for his heirs. Here is what he said on page 20 of the shareholder letter: 

"I believe the trust's long-term results from this policy will be superior to those attained by most investors - whether pension funds, institutions or individuals - who employ high-fee managers."

We have many more choice quotes on index funds from the Oracle of Omaha which are included in IFA's Quotation Database and are shown below:

"Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) of the great majority of investment professionals." - 1996 Shareholder Letter

"The American economy is going to do fine. But it won't do fine every year and every week and every month. I mean, if you don't believe that, forget about buying stocks anyway... It's a positive-sum game, long term. And the only way an investor can get killed is by high fees or by trying to outsmart the market." - 2008 Shareholder Letter
"the active investors will have their returns diminished by a far greater percentage than will their inactive brethren. That means that the passive group – the "know-nothings" – must win." - 2007 Shareholder Letter

"The best way in my view is to just buy a low-cost index fund and keep buying it regularly over time, because you'll be buying into a wonderful industry, which in effect is all of American industry...People ought to sit back and relax and keep accumulating over time." - CNBC Interview 5/7/2007