It's become one of the toughest sells of a fund manager: pay a fee to underperform the rest of the market.
Over the last three years, S&P calculates almost four in five domestic stock fund managers failed to beat broader indexes. Outdoing the market’s never been easy, especially after trading costs and fees. Now, more individual and institutional investors are concluding that active managers aren’t worth those extra fees. Last year, according to Cerulli Associates, $3.4 billion flowed into active funds, while index-based strategies pulled in more than $60 billion.
A new study suggests outperforming indexes has become even tougher. Even the smartest, best-informed managers are struggling to keep up. Professors at the University of Chicago’s Booth School of Business and University of Pennsylvania’s Wharton School analyzed how much managers contributed to fund returns. They found this measure of skill has tripled at the median fund, from adding about 0.01 percentage points per month in 1979 to about 0.03 percentage points in 2011. The edge brought by increased skill, however, was swamped by the effects of industry growth, which depressed returns across the board.
There are now more than 7,500 mutual funds, according to the Investment Company Institute. That’s 14 times more than there were in 1979. With so many more managers competing to deliver market-beating results, the study found, average returns are now 0.5 points per month lower than they’d be if competition hadn’t increased.
It used to be chummier and less cutthroat. When Bob Bacarella, 65, started investing in stocks 30 years ago, he could phone executives -- and actually speak to them -- while asking for information that could get someone thrown in jail today: "Hey, how were sales last week?’”
Now companies release news to all investors at once. Data points are instantly fed through sophisticated computer models and interpreted by squadrons of analysts. Research that used to take weeks must be shortened to hours or minutes. Managers say it's "bewildering and overwhelming," says Jason Voss, a former fund manager who’s now a content director at the CFA Institute
If skilled managers of active funds have such trouble, why not just rely on cheaper index mutual funds or exchange-traded funds that track broad market segments? Bacarella, now co-manager of the Monetta Young Investor Fund (MYIFX), says a good manager can help protect clients in down markets by limiting a fund’s risk exposure.
If fund managers' jobs have been reduced to minimizing losses, that's one more thing for them to worry about.