Lucky or Good? (Part 2)

Are mutual fund managers just lucky? Or really good?

A recent study by an index fund company found–surprise–that index funds outperform actively managed funds. Ken French and Eugene Fama looked at the aggregate performance of all actively managed mutual funds and compared it with the market, both before and after fees.

They found that before fees the active funds did add a little value. But their fees sucked all that up, and then some. In the aggregate, actively managed funds after fees underperformed a capitalization-weighted index of the entire market.

Well knock me over with a feather. Fama and French have just proven that 3 – 1 = 2. If you aggregate the entire mutual fund universe, you pretty much get the market. And if you compare it with the market, you get an identity. Now, if you subtract fees, you’ll get sub-market performance. Q.E.D.

This says nothing about whether certain managers can add value over time. It says nothing about whether someone was skillful or just lucky. It says nothing about whether beaten down stocks can return to favor, or whether high-flyers should come back to earth. All it says is A = A.

Fama and French have often been called the founding thinkers behind Efficient Markets, and much of their writing shows that outperformance is very, very hard. But this work only proves that when you look at research, be sure to note who paid for the research.

Douglas R. Tengdin, CFA
Chief Investment Officer
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