Mindless Comparisons to Index Funds

How often have you read that actively managed funds underperform a suitably chosen index? It is a lie.

The heart of the issue is the selection of a suitable index. What happens is that an actively managed fund is characterized after the fact. New indexes are created every day (or so it seems) to capture demonstrated management skill. Looking back, they do great.

Most investors are served poorly by funds with single-year benchmarks. Most investors are served poorly without adequate attention to both the downside risk and upside potential over a much longer timeframe. Retirees, in particular, need a sustainable income floor.

The actions of too many fund managers fail to match their rhetoric. Too often, we see high turnover rates. Anything above 20% to 25% is suspect. Fund managers are gambling to meet single-year objectives. They get paid exceedingly well if they do, especially if they can rack up a series of three or four “wins” in a row. Rhetoric about “long-term growth” really means “hitting a winning streak.”

The mindless comparisons to index funds make matters worse. It encourages gambling.

Before the year 2000, the standard for comparison was the S&P500 or, occasionally, an even broader index, the Wilshire 5000 (now under Dow Jones). That was because of a two decade bull market. Theory incorrectly claimed that this was always the best choice. Now that the bull has stalled, people are dismissing the S&P500 as too narrowly focused. They are looking for other indexes that beat actively managed funds. And they find them. After the fact.

Have fun.

John Walter Russell
October 31, 2006