The 'Average Returns' Myth

01/17/2017 04:52 pm ET Updated Dec 20, 2017

The mutual fund industry is bordering on panic. Check out these developments.

A summit meeting

According to The Wall Street Journal, 60 mutual fund executives held a summit meeting in early November. It was called: "The Seismic Shift Senior Leadership Forum." Its purpose was to brainstorm about how to stop the hemorrhaging withdrawals from actively managed funds to index funds.

I don't like their chances. Their business model is premised on the continued ignorance of investors who don't know that trying to "beat the market" is a zero sum game. The number of those investors is dwindling at a rapid rate.

The numbers are devastating

Actively managed fund managers have legitimate cause for concern.

Exchange-traded funds (which track an index) have accumulated almost $2.4 trillion in assets. In stark contrast, actively managed stock funds have seen outflows of $150 billion in 2016.

Hedge funds have seen net outflows of $77 billion.

This trend shows no sign of abating.

The reason is simple. Poor performance. Actively managed funds continue to underperform their benchmark index. For the past five years, an almost unbelievable 91.91 percent of large-cap managers lagged their respective benchmarks.

Hedge funds have fared even worse. As of November 18, 2016, the S&P 500 was up 9 percent for the year. The average return of all hedge funds was a meager 4 percent.

Investors aren't stupid. They are tired of paying high fees for underperformance.

A desperate lie

The securities industry is desperate. It can't dispute the numbers, which clearly indicate you would likely be better off investing in low management fee index funds, so it has concocted this big lie: Investing in index funds means you will be settling for "average returns."

The data tells a very different story.

Morningstar compiled percentile rankings for the 10 and 15-year periods ending December 24, 2013. Unfortunately, the rankings don't take into account the funds that went out of business during this time period or merged into other funds. This failure serious understates these findings.

Nevertheless, Vanguard's index funds, on average, beat 61 percent of actively managed funds over the ten-year period and 44 percent of those funds over the 15-year period. If the analysis had included funds that failed during this period, the record of Vanguard would have been much better.

Passively managed funds from Dimensional Fund Advisors did much better. On average, its funds outperformed 76 percent of actively managed funds over 10 years and 80 percent over 15 years.

These returns are far from "average."

Make your move

The financial media continues to act as a cheerleader for actively managed funds. Led by Jim Cramer, there's a steady parade of self-interested pundits telling you how to do your own research and pick stock "winners". Don't believe them. Do you really believe you have greater resources (including powerful computers) than hedge funds? With all their analytical muscle, their average returns were less than 50% of what you would have obtained by investing in a low cost S&P 500 index fund.

Actively managed funds are a sophisticated wealth transfer scheme. They prey on fear, ignorance and greed.

Don't remain a victim.

The views of the author are his alone. He is not affiliated with any broker, fund manager or advisory firm.

Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

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