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.

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?

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    Larry Swedroe is director of research for The BAM Alliance. He has authored or co-authored 13 books, including his most recent, Think, Act, and Invest Like Warren Buffett. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.

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