Active Fund Managers' Bear-Market Myth

(MoneyWatch)  Stock pickers will tell you that the best way to come out of a bear market with your investments intact is to subscribe to active management. That's simply a Wall Street myth.

A study in the Spring/Summer 2009 issue of Vanguard Investment Perspectives demonstrated the ineffectiveness of active management during bear markets. The author, Christopher Philips, found that "contrary to popular belief, actively managed funds, on average, have tended to underperform a broad market benchmark in bear as well as bull markets." The author also found that it is extremely difficult for investors to consistently pick the funds that outperform, and that index investors aren't disadvantaged during bear markets.

Consider some of these other statistics about active managers and bear markets:

• In the market correction of mid-1990, when the S&P 500 Index fell 14.7 percent, actively managed funds fell an average of 17.9 percent.
• In the bear market of July 16-August 31, 1998, the average equity fund lost 22.2 percent. This compares to losses of just 20.7 percent and 19.0 percent for a Wilshire 5000 Index fund and an S&P 500 Index fund, respectively.
• Standard & Poor's noted that the "belief that bear markets favor active management is a myth." It said that the majority of active funds in eight of the nine domestic equity style boxes were outperformed by indexes in the negative markets of 2008. It also noted the results were similar during the bear market of 2000-02.

The only really surprising fact is that the myth persists. Long ago, Nobel Prize winner William Sharpe demonstrated that, in aggregate, active managers must underperform simply because they have greater costs. While there are some funds that will outperform during bear markets, your chances of picking those funds are worse than a coin flip.