- Standard and Poor's Indices Versus Active Funds scorecard -- SPIVA®
If only I'd listened to Alf. American economist Alfred Cowles III (1891-1984) sought to "elevate economics into a more precise science using mathematical and statistical techniques," sez Wikipedia. Back in 1944 (I was 2, no wonder I didn't listen), he published his second report -- 11 years after the first -- in which he rated the performance of the leading financial pundits of his day. After analyzing data going back to 1927, he concluded that all the experts failed to consistently predict what the stock market would do, and that anyone who blindly invested in a representative bundle of stocks, one that tracked the market as a whole, would outperform the professionals.
If this sounds familiar, check out the latest Standard and Poor's Indices Versus Active Funds scorecard, or SPIVA®, which compares the performance of actively managed funds with that of passive funds. The first allocate stockholders' money based on the predictions of Wall Street financial gurus. Passive funds, on the other hand, simply track a benchmark such as the S&P 500. (This index, which averages out the performance of 500 of the largest companies in the country, is probably the best single gauge of the U.S. stock market.) The "manager" in this case is a computer.
Here's what the latest SPIVA® scorecard (second half of 2010) had to say about the previous 12-month period: "With the exception of emerging markets debt, over 50 percent of active managers failed to beat benchmarks." Over the previous three years, seven out of 10 managers were beaten by index funds. Another study, in the journal Economics and Portfolio Strategy, found that, of 452 managed funds between 1990 and 2009, only 13 outperformed the market average. (The February 2006 FPA Journal concisely summarizes the math of active vs. passive investing.)
What's wrong? The folks who manage these funds are the brightest and the best, Harvard-trained MBAs who pull in more money every week than most Humboldtians make in a year. How come they can't do a better job of forecasting? It's really no mystery. The stock market is an irrational beast, driven by the fears and hopes of millions of investors, big and small, reflecting not what's actually happening but what they all, as a single huge organism, believe will happen. In addition, active fund managers have to beat indexes by their 1- to 2-percent annual fees just to break even, and simple arithmetic says that, after costs, the average actively managed dollar must underperform the average passively managed dollar.
None of which, of course, will make the slightest difference to someone convinced he can beat the market (like me, until I saw the light) or to a confident fund manager buoyed by a few years' success. But the bottom line is, no one -- T. Boone Pickens, Warren Buffett, you or me -- can consistently forecast what's going to happen. Because it's a messy world out there.
Barry Evans (email@example.com) has no expertise whatsoever in financial matters, which is why he trusts his money to an unemotional computer.