MONEY MANAGEMENT

Yet another study shows that there is essentially no difference between actively managed mutual funds and index funds, especially once you consider the higher fees, writes MoneyShow's Terry Savage.

Are you still trying to outguess the stock market? That’s a futile proposition for even most professional money managers.

A new study by noted investment advisor Harold Evensky proves the point. An analysis of 20 years of mutual fund performance results—during both up and down markets, and good economic times and recessions—shows that there is no decided advantage in using actively managed mutual funds, especially when costs are taken into consideration.

The study itself was done with Professor Shaun Pfeiffer of Edinboro University in Pennsylvania. The goal was to compare performance of “index” funds, which are less expensive because they do no research and simply track the performance of a well-known index, with “actively managed” funds, which operate under the belief that research into securities and opinions on the trend of the market can deliver better than average performance.

There’s a lot riding on this long-running debate—literally billions of dollars in research expenses, sales, and marketing expenses, and an entire industry that tries to convince investors that their approaches can “beat” the market—and thus are worth the payment of additional management fees.

This particular study was designed to test the specific idea that actively managed funds are worth those fees, especially in declining markets. The idea is that smart managers can protect a portfolio against the declines that occur in the general stock market, which are fully captured if you’re in an index fund.

Evensky explained the point of the study to me: “The motivation for the research was to test the hypothesis that although active management may not work in all markets, it shines during bear markets. The traditional argument is that active managers, unlike index managers, do not have to remain invested.”

The results were interesting. The research found that, on average, active managers do outperform the benchmarks in down markets—by enough to justify the additional fees. But if you look over a cycle of both recessions and expansions, the active fund managers fail to beat the market indexes when fees are considered.

While that may not be enough to convince the ordinary investor of the value of a well-known portfolio manager, there is another important aspect to this study. The real issue is whether you can pick the fund manager who will outperform consistently!

The study shows a wide range of performance between the best and the worst fund managers. And making the task of choosing a winning fund manager even more difficult, there is no reliable indication that the fund managers who perform well in one phase of the cycle, such as a recession, can translate that performance into the next phase—a period of growth.

In fact, the study shows that funds that performed well during a recession are unlikely to deliver a repeat performance during the next up cycle! Or as the red print on the cover of the mutual fund prospectus says: “Past performance is no guarantee of future results.”