Paul Meloan – Vested Interest

For a while now, Standard & Poor’s has been running a report card on the long-term performance of active asset managers versus their benchmarks.  (NOTE: this will be making up a good part of our Fundamental Fridays segment in coming weeks.  If you are not up on all the lingo just yet, I will keep it simple here).

Mutual funds that are actively managed attempt to attract investors with the promise of returns higher than a given benchmark.  The most famous of these benchmarks is the S&P 500, an index of 500 of the largest publicly traded companies in the U.S.  Why does this matter?  Because in order to justify their higher management fees, the mutual fund in question must offer at least the prospect of beating the index.  An investor could simply buy the index and call it a day.

In its most recent edition, the report card said that 64% of active U.S. large cap mutual funds failed to beat the S&P 500.  They should not feel singled out: their counterparts in just about every other asset class failed to beat their respective benchmarks as well.  The exception? International small cap managers.  Why?  Who knows.  Even the 1962 Mets managed to win a few games.  All of these figures are measured over a five year period.

To those of us who have been squarely in the passive camp for a long time this is nothing new. 

What is interesting is that the report card put a number on the mutual funds that disappear over that period of time.  A full 20% of domestic mutual funds failed to survive the five years measured in the study.  One-In-Five.  These funds either merged into other funds or liquidated completely.

With a casualty rate that high, one might wonder how managing someone else’s money could be such a dubious business proposition.  It makes it all the more puzzling why someone would commit to a program that invests in the same assets as an index fund, yet has higher costs and such a high probability of failure.

Paul Meloan is the co-founder and co-managing member of Aegis Wealth Management, LLC, in Bethesda, Maryland USA. Before Aegis Paul was a practicing attorney as well as working in the tax practice of Ernst & Young, LLP.

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