Only luck, not skill, helps some active funds outperform
Stock mutual funds that actively investigate, select, buy, and sell stocks claim to have the skill to outmaneuver the mass of investors.
Yet another detailed study says there may be no truth to those claims. When individual active funds do manage to beat the market for a time, they do so merely by luck rather than skill.
A massive study that ran thousands of simulations of performance of actual stock mutual funds found virtually no evidence that any fund managers beat the market after the funds’ cost of investing.
The study was done by famed investment professors Eugene F. Fama of the University of Chicago and Kenneth R. French of Dartmouth College.
“The challenge is to distinguish skill from luck,” they wrote. “Given the multitude of funds, many have extreme returns by chance.”
The study covered stock mutual funds in existence between 1984 and 2006. They looked at actual returns and did 10,000 simulations of returns. “For fund investors the simulation results are disheartening,” they wrote.
Although some fund managers beat the markets on a gross return basis, after the funds’ costs they did not. “Thus, if there are managers with sufficient skill to cover costs, they are hidden among the mass of managers with insufficient skill,” Fama and French said.
They found that only about 2 percent of funds appeared to have the skill to overcome average net investing expense of 1 percent.
What’s more, there is no evidence that an investor can identify any of those managers in advance of their market-beating performance.
The bottom line is that passively managed funds that stick to a total market allocation offer assurance of obtaining the market’s returns.