Beating the S&P 500
Approximately 75% of fund managers do not beat the S&P 500 index year in and year out. How can a basket of 500 hundred stocks beat the majority of actively managed mutual funds? The people who manage these funds are, for the most part, brilliant people. They are highly educated and have access to the most advanced information and decision support systems in the world. So why is it that even they do not outperform the S&P 500?
A Quick Test
Here's a very crude test of management performance: Let's compare the domestic-equity mutual fund performance supplied by Morningstar against the S&P 500 index for one, three, five, and ten-year periods, looking back from April 30, 1995. The S&P 500 index is a fair comparison for large, domestic companies. Our results:
- Of the 1,097 funds Morningstar covered for the one-year period, 110 beat the S&P 500, while 987 fell short. Results ranged from 46.84% to -32.26%, while the S&P 500 attained a 17.44% return.
- During the three-year period, the S&P 500 returned 10.54%, while results in the funds varied from 29.28% to -15.02% compounded annually. Of the total 609 funds, only 266 beat the S&P 500.
- Shifting to the five-year period, of 470 funds, 204 beat the S&P 500. Results ranged from 27.35% to -8.51%, while the index racked up 12.62%.
- At ten years, only 56 of 262 funds managed to beat the index, and results varied from 24.77% to -4.06% compounded annually against 14.78% for the S&P 500.
Some Reasons Why
The implied promise held out to investors in actively managed mutual funds, is that in exchange for higher fees (relative to index funds), the actively managed fund will deliver superior market performance. There are a host of barriers to fulfilling this implied promise. Some of these barriers are:
- The larger a mutual fund gets the more difficult it becomes to deliver exceptional performance.
- Although fund size runs counter to performance, fund managers have a strong motivation to let the fund grow as large as possible. The larger the fund gets, the more money the fund managers make.
- The most skillful mutual fund managers are hired away by hedge funds - where their financial rewards are greater and there are fewer restrictions on investment techniques.
- By law, mutual funds are supposed to be conservative, which in theory limits their potential losses. This conservative stance generally limits their ability to use arbitrage, options, or shorting stocks.
Can You Do Better?
Because of the general inflexibility and restrictions of most mutual funds, your investment capital is not properly hedged against market fluctuations. In most cases, if you compared the beta of the equity exposure held in actively managed mutual funds to an equal equity exposure to the S&P 500 index, your reward/risk ratio would be less rewarding than purchasing an identical equity exposure to the S&P 500 index.
We passionately believe in the concept of active money management. There is simply no reason to buy-and-hold any mutual fund, stock, exchange traded fund, etc. If you would like to learn more about the benefits of ProfitScore's active money management strategies, please contact us.