It’s very hard to beat the stock or bond markets with any regularity.
Each year, some investors manage to do it, of course, but can they do it consistently? A new study of actively managed mutual funds by S&P Dow Jones Indices asked that question and came up with a startling result.
It found that not a single mutual fund — not one — managed to beat its benchmark in either the U.S. stock or bond markets regularly and convincingly over the last five years. These results are even worse than those of 2014 and 2015, when I last examined this subject closely.
“If you want to be adventurous and pick stocks or actively managed funds, go ahead, of course,” Tim Edwards, global head of index investment strategy at S&P Dow Jones Indices, said in an interview. “But understand the risks you are taking.”
These findings support practical advice that has been the academic consensus for decades. Forget about trying to beat the odds and outsmarting everybody else. Instead, use low-cost stock and bond index funds that mirror the overall market, and keep them for decades. Don’t bother with fads or fancy market timing.
While it’s possible to beat index funds, it’s not easy to do over the long run, and as Paul Samuelson, the first American to win the Nobel in economics said in the 1970s, it isn’t worthwhile for most of us to try.
Yet especially in a year like this — when both the stock and bond markets have had horrendous losses — it’s tempting to seek a better way. Why stick with index funds, which merely match the market, and ensure that you have had what any sane person would consider terrible results?
Picking stocks and bonds on your own — or getting a professional to do it — may seem a better way to go. But before you take that route, examine the latest evidence. It shows that as bad as index funds have been, actively managed funds have generally been worse.
The Scorecards
For 20 years, S&P Dow Jones Indices has been providing “scorecards” that compare the performance of active mutual fund managers with a series of benchmarks, or indexes, that capture the broad stock and bond markets, or discrete pieces of them. Many mutual funds and exchange-traded funds mirror these indexes, and a basic question for any investment strategy is: Does it beat the index? S&P Dow Jones Indices also tabulates how many funds beat the indexes persistently, year in and year out.
In a nutshell, these report cards have never been particularly good for actively managed funds. The studies have found that most actively managed mutual funds do worse than their benchmark index, both over the long run and in the vast majority of calendar years, in the United States and elsewhere around the globe. For example, the last time the average active U.S. stock fund beat the S&P 500 stock index for a full calendar year was in 2009. And over a full 20-year period ending last December, fewer than 10 percent of active U.S. stock funds managed to beat their benchmarks.
Still, every year, some actively managed funds do outperform the indexes. If you own one that does, you may not care about all the others that fail to do so.
But then the issue is, will this outperformance persist? Another way of putting the question is this: Are these funds beating the market because they are lucky or because some investors are more skillful than others?
There is no absolutely correct, quantifiable answer to these questions. Some investors are undoubtedly more knowledgeable than others and make better decisions. But are they good enough to stay ahead of the market year after year, especially when fees and expenses are included?
The most recent evidence isn’t encouraging.
You may think that it’s easier to beat the market when stocks and bonds are falling in value. As it turns out, that’s not the case.
Lack of Persistence
Over the last five years, not a single mutual fund has beaten the market regularly, using the definition that S&P Dow Jones Indices has employed for two decades.
The S&P Dow Jones team looked at all the 2,132 broad, actively managed domestic stock mutual funds that had been operating for at least 12 months as of June 2018. (The study excluded narrowly focused sector funds and leveraged funds that, essentially, used borrowed money to magnify their returns.)
The team selected the 25 percent of the funds with the best performance over the 12 months through June 2018. Then the analysts asked how many of those funds remained in the top quarter for the four succeeding 12-month periods through June 2022.
The answer was none.
Not a single one of the initial 2,132 funds managed to achieve top-quartile performance for those five successive years. That hasn’t happened for stock funds since 2011. This time, S&P Dow Jones Indices did the same measurements for fixed-income funds and came up with the same result: zero. Not a single bond fund remained in the top quarter for every 12-month period.
While scoring in the top 25 percent year after year is a fairly high hurdle, it strikes me as a reasonable one. But S&P Dow Jones Indices also used an easier test. How many funds ended up in the top 50 percent year after year over five years? For those 2,132 stock funds, the answer was only 1 percent. That’s still a dismal result.
Consider a very big public school with more than 2,100 students in a class. Not all the high performers will always score in the top 25 percent of their class, but I’d expect that at least some of them would, every year, over five years. If not a single person managed to do that, I’d wonder why. If only 1 percent — 21 of 2,100 — had better-than-average performance every year over five years, I’d think that something was wrong with the school or with the scores.
The Implications
Why did all the actively managed funds perform so badly in the S&P Dow Jones tests? In an interview, Mr. Edwards said two things were going on.
“First, it’s always hard to consistently beat the market,” he said. “We’ve got two decades that show that. Very few people can do that in the best of times.
“The more subtle thing is the fact that no one has been able to do it lately,” he continued. “And what that shows is that whatever worked well for investors from, say, 2017 to 2021 just didn’t work in 2022, when the markets turned.” In other words, the markets are efficient enough that it’s hard to be better than average for long, and when trends change sharply as they did this year, nearly everyone is wrong-footed.
This is a classic reason for relying mainly on index funds — essentially, accepting overall market returns, no better and no worse. Note that for the 20 years through June, the S&P 500 annually returned more than 9 percent, on average — which means your investment doubled in value every eight years. That’s roughly what an index fund would have done for you — and it’s better than the vast majority of actively managed funds were able to do.
On the other hand, given this year’s losses in both stocks and bonds, it’s also clear that investing in broad, diversified index funds is no panacea. These funds don’t protect you when the market falls. And they have other major problems, which I’ll come back to in other columns: They don’t allow you to vote directly on the policies of individual companies, and they include within them companies that you may dislike or even abhor.
Some actively managed funds did better than the overall market over the last 15 or 20 years. Though they were unable to do so consistently year after year, they had good stretches, and those periods were strong enough to make them outperform over the entire span. Such funds may well be worth owning.
“Those that have managed to do that are impressive,” Mr. Edwards said. “But which funds will be able to do it over the next 20 years?” Unfortunately, we don’t know.
That’s why cheap, broad index funds make sense as core investments for the long haul, even in a year like this one, when the markets have been falling.
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