Indexing is on top, but active management can play a role, too


The last few years have indeed been kind to indexers. According to the Standard & Poor’s Index vs. Active (SPIVA) Scorecard, a semi-annual report that compares actively managed funds to their benchmarks, active funds are lagging. According to the data, just 7.8 percent of large-cap funds, 5.6 percent of mid-cap funds and 6.8 percent of small-cap managers trail their benchmarks over the 15-year period. The numbers tell a similar story in the short- and intermediate-term, as well.

“We’ve been in a large-cap growth market where it’s been very difficult to outperform the S&P 500,” Brown said.

Index funds have a couple of things going for them that make it hard for active managers to compete. First, they tend to have low fees. The average actively managed fund has an expense ratio that’s almost twice as high as the typical index fund.

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Then, there’s stock picking. Even the staunchest index adherents believe that active managers can get lucky now and then, but it’s not usually a skill that can be sustained. A recent study by Hendrik Bessembinder, a professor in Arizona State University’s business school, found that since 1926, the entire net gain of the U.S. stock market can be attributed to just 4 percent of companies. The remainder of the stocks either had returns in line with Treasury bills or worse.

What that means, contends Paul Merriman, a retired financial planner, is that it’s really hard to isolate the winners. Merriman is now the founder of the Merriman Financial Education Center in Seattle, which aims to increase financial literacy.

“There’s no evidence that active management is going to raise your return,” he said. “That’s no different than having half your money in T-bills.”

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