Column: “Whack-a-mole” fund managers can’t beat the market

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Commentary by Adam Cmejla 

If you are a disciple of “active management” in the investment world, then you are a strong believer in the notion that gifted and talented fund managers can identify stocks that will rise in price and turn away from those that will decline in value. In theory, they can identify – before anyone else and before any market decline – when it’s the best time to get in and out of the market. Ergo, their mission is to “beat the market.” Their expertise, skills, and goal to outperform is used to justify their (usual) higher costs and turnover (thus potentially higher tax consequences) as compared to traditional “indexing” or other, more evidence-based investment philosophies. The data, however, speaks otherwise.

Standard & Poor’s released its year-end 2013 “S&P Indices Versus Active Funds Scorecard” that compares the performance of actively managed mutual funds to their S&P benchmark indices. For the five years that ended on Dec. 31, 73 percent of large-cap domestic funds, 78 percent midcap funds, 67 percent, and 80 percent REIT funds underperformed their benchmark indices. Almost two thirds actively managed domestic stock mutual funds underperformed the S&P 1500 total stock market over the past five years. (For the complete study, check out my tweeted link @acmejla).

I prefer to call “actively managed” the conventional approach to investing. There are four themes that I derive from conventional investing.

First, it relies on predictions about an individual stock or investment and how it is going to perform in the future. Not only that, but you’re in essence betting that you know more about where that stock is going to go than the collective knowledge of the entire market! Think about it: if you were right, and everyone else agreed with you, then the price would already be what you thought it was going to be. Simple economics.

Second, there’s the behavioral element to this type of investing. It’s not what the market does, but rather what you do and what you get once emotion is introduced into that equation.

The role of the media is the third element. Investors and fund managers tend to think that events cause investments to change in price. An illustrative example would be “Stocks drop on Ukraine Concerns, down 100 points.” There’s no concrete causality between those two events, but investors and money managers alike make decisions based off of media reports

Fourthly, there’s the social element of investing. The fund manager’s ego, excitement, and competitive nature can figure into the equation, thus skewing results.

Add to all this, there are now more “swimmers in the pool.” The number of fund managers competing and vying for the same information and same securities has introduced a level of parody in the investment universe that’s never been seen. Thus, if you’re one of one trying to “whack as many moles as you can”’ in a period of time (i.e. outperform the averages), you stand a much better chance than if there are nine other whackers aiming for the same target. The real message: Why fight against the collective wisdom of the entire market?

Adam Cmejla, CMFC® is President of Integrated Planning & Wealth Management, a comprehensive financial services firm located in Carmel providing comprehensive retirement planning strategies to individuals near or in retirement. He can be reached at 853-6777 or adam@integratedpwm.com.

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