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Active Managers Take a Beating in 2010

According to data from Bank of America Merrill Lynch, the failure of active management has never been as strong as it has been this year.

Overall, about 25 percent of active managers beat their benchmarks, with BoAML calling this the "toughest year on record" for active managers. Looking deeper, about 33 percent of growth managers, 18 percent of value managers and 12 percent of core managers demonstrated outperformance.

The failures of active management have been documented and discussed at length. So why do so many people keep falling for what should be considered a scam? Excuses, optimism and the hope of next year. In its report, BoAML noted three reasons being cited for the underperformance:

  • High correlations
  • Low spreads on returns
  • Better-than-usual returns on illiquid stocks
Well before the end of the year, active managers were already issuing their excuses. In September, active managers were blaming high correlations and macro pressure (or big picture items such as the economy or politics) for their strategies failing.

The details may vary, but the story never changes. When active managers outperform, it's always because of their brains and hard work. When they underperform, it's always because of something outside their control. You never hear costs or lack of ability cited as reasons for underperformance. This allows investors to believe that things will be different next year, as active managers "account" for these issues.

Perhaps this is why about two-thirds of active investors expect to beat the S&P 500 Index next year. (Of course, that implies one-third don't believe they'll top the benchmark and makes me wonder why they're actively investing in the first place, but I digress.)

This is one of the underrated benefits of passive investing. You don't have to listen to excuse after excuse from your advisor, covering up the real reasons they underperform: The markets are too efficient, and their crystal balls are always cloudy.

More on MoneyWatch:
Active Managers Continue Lagging Their Benchmarks Vanguard's Case That Passive Management Works Why Buy-and-Hold Isn't a Good Strategy A Simple Way to Beat the Market Who's Smarter: Active or Passive Investors?
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