In a blog war on CBS MoneyWatch, Robert Hagstrom notes how he can beat the market while Charles Ellis, co-author of Elements of Investing, along with Burton Malkiel, states the case against active investing.
Hagstrom notes that if the market goes sideways for the next few years, index funds won't make much more than the two percent dividend yield. An active manager, however, can pick the right stocks at the right time.
Many investors are caught up in the debate on the Efficient Market Hypothesis and forget that the active - passive debate can be settled by simple arithmetic. The market is mostly professional investors charging about two percent annually in stated and hidden fees. If Hagstrom is right that the market goes nowhere in the next few years, then the average active investor will earn two percent in dividends and then pay the same amount in fees. In short, the average active investor will make nothing.
What's Legg Mason's track record?
Let's say I'm wrong and 90 percent of investors really can be above average. How has Legg Mason performed in it's stock picking ability? It turns out, not so well.
Remember that a Morningstar rating of three is an average performance of a mutual fund, and that an average mutual fund under-performs the market. Legg Mason has a 1.4 average Morningstar performance rating for domestic stock funds. Its rating is one of the lowest of any mutual fund families.
What's Hagstrom's Track Record?
I know, Hagstrom doesn't manage all Legg Mason funds. He is the manager for the Legg Mason Capital Management Growth Fund (LMGTX). Depending on what share class you look at, Morningstar gives it a one or two star rating. In the bear market of 2008, it lost 60.44% of its value! This means, in order to get back to its 2007 value, it will need a 153% percent gain.
Sure, any manager can have a bad year, so how has he done over the past ten? He has badly lagged both the S&P 500 and the total US stock market. Not only is performance lower, the risk, as measured by the standard deviation, is much greater than the stock market as a whole.
Talk is seductive and persuasive, but it is also cheap. It's easy to claim we beat the market, yet very few do. I appreciate Robert Hagstrom's point of view and acknowledge that I'm sure he truly believes in his stock picking ability. I'm going with Charles Ellis on this blog war, and it's not a close call.