Another poor showing for active managers

(MoneyWatch) The debate about which strategy -- using actively managed or passively managed funds -- is the most likely to allow you to achieve your financial goals should have ended long ago. Yet, the debate continues, and it will probably continue for a very long time, despite evidence such as the Standard & Poor's Indices Versus Active scorecards. The latest one, measuring persistence in fund performance, provides further evidence of passive investing as the winning strategy.

S&P first measured performance over three consecutive 12-month periods. Of the 707 funds in the top quartile (meaning top 25 percent) of returns for the 12 months ending September 2010, 37.3 percent stayed in the top quartile for the next 12 months. You should expect that half would have repeated the performance by sheer chance. Even worse, only 10 percent stayed in the top quartile for two subsequent 12-month periods. Randomly, 25 percent should have done so.

• Active managers lag index counterparts -- again
• Active management fails again
• The best managers don't stay at the top

Looking longer term, S&P also looked at performance of five consecutive 12-month periods. Not a single large-cap, mid-cap or small-cap fund managed to maintain top quartile performance for five straight 12-months periods, ending September 2012. (A few multi-cap funds managed to pull off the feat.)

The bottom line is that active manager performance has basically been at or below the levels one expects based on pure chance. This lack of persistence makes it very difficult to separate skill from luck. This is why you should always remember that past performance is no guarantee of future success. Unfortunately, it's estimated that perhaps only about 15 percent of individual investor assets are in index funds. That means the other 85 percent is playing the loser's game. Which one are you playing?

[LarryswedroeCBS]

Michael sorry for that error
Looking at the longer term data we find that only 5.16% of large-cap funds, 3.21% of mid-cap funds and 5.10% of small-cap funds maintained a top-half performance over five consecutive 12-month periods. Random expectations would suggest a repeat rate of 6.25%.

[Michael James on Money]

Hi Larry,

You've misread the tables in this report. 37.3% stayed in the top quartile, which should be compared to an expectation of 25% if results are random. The 10% that maintained this top quartile ranking for two additional years should be compared to an expectation of 6.25% based on random results.

So, there is a small amount of persistence, but nowhere near enough to reliably choose winners. So, your main conclusion still holds.

Cheers,

Michael James