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Active Managers Continue Lagging Their Benchmarks

It seems that a good myth is hard to kill when an entire industry depends on it. Standard & Poor's latest Persistence Scorecard shows that active managers continue to underperform at a rate far worse than chance.

For the five years ending September 2010, only 4.1 percent of large-cap funds, 3.8 percent of mid-cap funds and 4.6 percent of small-cap funds maintained a top-half ranking over five consecutive 12-month periods. Randomly, we should expect 6.25 percent to achieve this feat.

The statistics don't get much better for active managers over a longer time period. S&P examined the performance of funds that had a top quartile ranking for the five years ending September 2005. Randomly, we should expect 25 percent of these funds to maintain such a ranking over the next five years. During the next five years, those funds maintaining their top-quartile rankings amounted to:

  • 14.2 percent of large-cap funds
  • 8.5 percent of mid-cap funds
  • 27.3 percent of small-cap funds
However, active managers were consistent in one area: the death rate of the bottom feeders. Across the board, fourth-quartile funds have a much higher rate of being merged and liquidated.

I'm sure you're well aware of the SEC required disclaimer that "past performance is not an indicator of future outcomes" (or some variation thereof). Despite that disclaimer, the majority of investors make investment decisions based on the assumption that past performance matters. This behavior is hard to explain in light not only of the SEC disclaimer, but also the volumes of academic research that demonstrates that the SEC disclaimer is far too mild. The historical evidence actually reveals that past performance has virtually no value as a predictor of future performance. The only evidence of persistence in performance beyond the randomly expected is that poorly performing funds that have high expense ratios show persistently poor performance.

More on MoneyWatch:
Active Bond Managers Fare No Better The Economy Isn't the Same as the Market Why the Concern over Negative TIPS Yields Is Overblown When Dollar-Cost Averaging Makes Sense When Dollar-Cost Averaging Doesn't Make Sense
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