Funds: An Awful Year for Active Managers

In the past year, fund managers have flopped.

I’m not just talking about the likes of Bernard Madoff. Your honest, everyday mutual fund stock picker has also done a lousy job.

According to TrimTabs Investment Research, the net asset value of equity mutual funds is down 45% in the last year. According to Morningstar, the average domestic stock fund is off 42% this year. (The broad S&P 500 stock index is off “only” 38%.)

Of the thousands of domestic equity funds tracked by Morningstar, not one is likely to provide a positive return in 2008.

Active managers of stock funds usually have a hard time beating the performance of the broader market. That’s one reason I and many other people choose to invest in low-fee, passively managed stock index funds rather than managed mutual funds.

Many assume, however, that active managers will do better in tough markets, when they can take advantage of volatility and market irrationality to make money for their investors.

Tim Byrne, Director of Wealth Management Research at Robert W. Baird & Co., studied the issue and found it is true historically — at least over the last 20 years — that “active managers tend to perform best (i.e., provide the most excess return) in negative return environments. [They] have proven to be better at down market protection than up market protection.”

So why this year, during the toughest market in a lifetime, have active managers flopped?

This is not like other bear markets, Byrne says. “The sell-off was broad in nature, offering little opportunity for avoidance.” Only 7% of the S&P 500 posted a gain in the 12 months ending Oct. 31, 2008, Byrne notes. In the terrible year for the market ending Sept. 31, 2001, however, 45% of stocks moved higher.

“There has been no place to hide in the equity market,” Byrne says. Large, mid or small-cap, value, core or growth, U.S. or international — all the categories dropped 30% or more.

Some active managers may still be providing value for investors, though it’s never easy to know who those will be in advance. A vast array of respected managers are struggling, Byrne notes, including Bill Miller, Ken Heebner, Fidelity’s Will Danoff and others.

I wonder if this market might eventually move from a crisis mode into more normal bear market conditions, i.e. conditions more typical of past recessions. If such progress occurred, active managers might make themselves more useful. For now, it’s a tough time to be picking stocks.

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