A Second Look at the Mutual Fund Landscape

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A few months ago, we published “The Mutual Fund Landscape—Not a Pretty Picture” in which we presented the results of research by Dimensional Fund Advisors (DFA). To summarize, they found that over the ten year period ending 12/31/2012, less than 20% of actively managed funds both survived and beat a risk-appropriate benchmark. Furthermore, recent outperformance of a benchmark has zero predictive value for future outperformance.

This past week, Vanguard Research published their own study1 that yielded similar results. Specifically, they started with 1,540 active funds that existed on 1/1/1998 and tracked them for the 15-year period ending 12/31/2012. They found that 698 (45%) of them closed, 567 (37%) survived but underperformed, and only 275 (18%) both survived and outperformed. The chart below summarizes the results.

Given that a would-be manager picker had less than a one-in-five chance of picking a winner, Vanguard asked what degree of underperformance he would have had to endure during the 15-year period to capture the outperformance for the whole period. For starters, 268 (97%) of the 275 winners had at least five years of underperformance. Furthermore, 181 (66%) had at least three years of consecutive underperformance. Honestly, how many investors would have had the gumption to hold these funds for the entire 15-year period? For those manager pickers who decided to switch horses in the middle of the race, Vanguard demonstrated that it would have been easy for them to find a fund that had outperformed during the period when their own fund had underperformed. Of course, they would have had no reliable way of telling if the observed outperformance was due to skill or if the observed underperformance was due to bad luck overpowering skill or just simply a lack of skill.

No one should be surprised that our conclusion regarding the cause of the pervasive underperformance of active management remains unchanged—market efficiency. These 1,540 managers are competing not just with each other but with hundreds of thousands of other traders who are all looking at the same 12,000 stocks. The number of active managers who can both overcome their costs and beat a benchmark has been quite small. There is no logical reason to expect that to ever change.

If you are currently on the manager picking treadmill and would like to learn about a better way to invest via index funds, please call us at 888-643-3133.


1Wimmer, Brian R., Sandeep S. Chhabra, and Daniel W. Wallick, 2013. The Bumpy Road to Outperformance. Valley Forge, PA: The Vanguard Group.