There are compelling reasons not to invest in actively managed funds. Not only do most of them fail to out-perform the S&P 500 or their market sector average, but some of your money is going to hire the funds’ managers instead of going directly into your investments. It is easy to understand why so many investors have chosen the path of passive fund investing, where they beat most active investors, and don’t have to pay big management fees. Passive investing has revolutionized the market by adding a healthy amount of stability and predictability. It’s the investment story of the decade, and investors of every level of wealth have participated.
So what’s the problem? There is none, but there may be an opportunity. Investors who have abandoned active funds may have acted too hastily, as there are still compelling reasons to seek these funds out. First, it is a logical fallacy to assume that the average performance of all active funds is a pertinent metric when examining the potential returns of a specific managed fund. Suppose we replace all the players on the Cleveland Cavaliers except LeBron James with second-string middle-school players. Now the average ability of the Cavaliers is terrible, so should we conclude from that that LeBron James is now terrible as well?
Put another way, neither the number of fund managers who fail or the degree to which they fail tells us anything about the fund managers who are succeeding, how likely they are to continue succeeding nor to what degree they will likely succeed. There are two things we actually do want to look for. One: what is the return over time and how does it compare to the market / industry index, and two: total amount of time. Why the second? To filter out luck to the extent that we can. Thrashing the market for two years means nothing, because probability indicates that a many, many people are likely to do it, but beating the market for ten years in a row, in up markets and down? More than likely, that’s talent at work.
As always, remember to treat these ideas as just that, ideas, and do your own research before making any investment decision.