Are Stock Pickers Getting Desperate?

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We ask this question after reading this interesting article by David Randall from the Daily Mail. We believe the author was being polite in his word choice of “creative” rather than “desperate?” In prior articles such as this one, we have noted how 2014 was an extraordinarily difficult year for active managers. The Daily Mail article states that passive funds brought in $166 billion in new investor dollars while, while investors pulled $98 billion out of actively managed funds. Randall notes that more than half of the newly introduced funds in 2013 focused on niche strategies or markets. The two funds he specifically mentions are the ATAC Beta Rotation fund, which engages in sector rotation based on inflation expectations, and the 3D Printing and Technology Fund. The latter one reminds us of the PowerShares Lux Nanotech Portfolio ETF which was liquidated in 2014 due to poor performance and subsequent abandonment by investors. We specifically warned investors about this fund in this article from 2011.

This brings up another problem with active management, survivorship bias, which we have previously discussed here and here. Randall cites Lipper data stating that the average fund lasts just 7 years before it’s closed. These new funds face a strong headwind in the underperformance of active funds in 2014 by an average of 3.1% compared to their passive counterparts, the widest margin in more than years according to Lipper. Randall obtained a few choice quotes from proponents of active management such as James Oberweis who said, “Even the most ardent proponents of the efficient market hypothesis will say that there are pockets of inefficiencies, and the most common is small-cap and international stocks.” We have to disagree with this assertion which we addressed in this article where Professor Fama succinctly states that there is no convincing evidence for the existence of asset classes that are somehow exempt from market efficiency. His long-time collaborator Ken French goes on to build a logical case for why these elusive asset classes simply don’t exist. We also brought forth some Vanguard Research data in this article stating that 84% of active small-cap blend funds and 71% of active emerging-market funds underperformed their low-cost index fund counterparts for the ten years ending 12/31/2013.

As usual, the stockpickers plan to rely on short-term performance to attract investor dollars. As John Langston of the newly launched Panther Small fund said, “If you’re putting up good performance numbers, that’s the best way to get your story out there and hope investors follow.” We at Index Fund Advisors hope that investors are smart enough not to be taken in by statistically insignificant recent returns.