Super Nova to Black Hole
William Bernstein, author of The Investor’s Manifesto: Preparing for Prosperity, Armageddon and Everything In Between, talks of the “Big Lie.” Here, refers to the myth that while indexing works for large-cap stocks, active managers still possess an edge in picking foreign and small-cap stocks.
While this big lie has been supported by some industry heavyweights, ie Fidelity chief Robert Pozen who said, "Active managers beat the relevant indexes on a regular basis for things like international funds, small-cap funds, etc.," this assertion bears no basis in reality. Active managers do not beat the indexes on a regular basis --unless by regular you mean a vast minority of the time. In fact, active managers typically fail—by a huge percentage of some 92% across asset classes, including large-cap, small-cap, emerging markets, international and fixed income. No, active funds do not regularly beat indexes over the long term.
Here are several comparisons of active equity fund managers versus index funds or indexes. As you can see passive beats active no matter how you slice it.
(Click Here to see the enlarge chart)
These many equity and fixed income studies show that when William Bernstein refers to “The Big Lie”, there is no exaggeration in the use of the adjective “big.” It fact, it’s quite an understatement. The scope of the deception that managers beat markets is enormous, and sadly quite destructive to an individual’s ability to accumulate wealth. Investors who rely on the false promise that managers add value pay more to earn less. The weighted average expense ratio on international active funds is three times higher than its passively managed counterpart – and they clearly do not justify the increased expense.
Finally, a 32-year study showed just how likely the chance of success is for an active manager to actually possess skill enough to beat an index—less than 1%. That’s right, 99.4% of the time, active fund managers were shown to lack skill sufficient to beat a simple market index.
Jason Zweig described some of “hot” active managers from the past, "Most depressing of all, the "superstar" fund managers I encountered in the early 1990s had a disconcerting habit of fading from supernova to black hole…I soon realized that if you thought they were great, you had only to wait a year and look again: Now they were terrible."