INDEX FUND INVESTORS can take a victory lap each time the Standard & Poor’s Index Versus Active (SPIVA) scorecard is published. The results, while they don’t change much, underscore how futile it is to try to pick winning fund managers. The year-end 2021 report concludes what so many of us already know. Still, it’s helpful to be reminded, so we don’t get lured in by the latest hot investment narrative.
The 2021 numbers reveal a dreadful year for investment managers. Among U.S. stock funds, 80% lagged behind the S&P Composite 1500 index—a broad gauge of the market from small- to large-sized stocks. Out of the past 20 years, only 2011 and 2014 were worse for fund managers. Take a 10-year perspective and you’re even more challenged to spot winning portfolio managers—a measly 14% of U.S. active stock funds beat the market over the past decade.
Here are stats I find astounding: S&P reports that “5% of funds across asset classes and categories were merged or liquidated in 2021. Over 20 years, nearly 70% of domestic equity funds and two-thirds of internationally focused equity funds across segments were confined to the history books.”
That means most stock funds that were around in 2002 are gone today. In finance parlance, we call this “survivorship bias.” Funds that perform poorly tend to vanish. Clever fund companies might shutter an underperforming strategy and then later make a comeback with a clean slate when market conditions change.
Why do so many professional managers fail to beat a plain-old index fund? Here are three key reasons:
1. Investment costs. Mutual fund managers aiming to beat the market must pay a team of analysts and cover all the overhead expenses of running a business, not to mention paying themselves handsome salaries. Trading in and out of stocks also costs money, plus it can run up your tax bill, too. All this makes it tough to beat index funds, which cost basically nothing.
2. Overconfidence. Thinking you know more than the next investor takes a certain cockiness. It causes active stock pickers to take on too much risk, often leading to losses versus the index. On the flip side, bearish portfolio managers might end up holding too much cash for too long, waiting for a stock market crash.
3. Competition. Smart finance folks are numerous nowadays. There are more than 175,000 CFA charterholders around the world, all trying to uncover diamond-in-the-rough stocks. Think of it this way: It was easy for six-foot-ten NBA legend Bill Russell to dominate in his era. Basketball was still new. Today, players from across the globe strive to become professional basketball players. There’s more and better competition. It’s the same thing in the high-stakes game of stock picking.