May 2, 2009 in City

Bust market myths

Mark Jewell Associated Press
 

BOSTON – In a tough market that’s still down despite an April rally, you’d think it would be worth paying for the expertise you’ll get from having professionals manage your mutual fund.

Thanks to the human element, there’s at least a chance you won’t get hurt if the market’s recent momentum shifts. Fund managers should know when to change course before a stock or bond begins to lose value. And they can play it safe by holding plenty of cash rather than staying fully invested in a declining market.

Index funds, your chief alternative, offer cheaper expenses. But because they passively track a market index – the investing equivalent of autopilot – you’re guaranteed to go down if markets head south again.

But when stock prices dive, statistics haven’t shown clear evidence that active funds offer any more shelter than index investing. And in the current bear market, the numbers show index funds are producing better returns, by a wide margin.

In 2008, 64 percent of actively managed U.S. stock funds were beaten by a broad market index, the Standard & Poor’s Composite 1500, according S&P Index Services. S&P, which has released index-vs.-managed scorecards over the past seven years, found actively managed funds fell short almost across the board. In eight of nine domestic stock fund categories, a majority of such funds were beaten by their performance benchmark index.

“The strident belief that active managers do well in down markets is a myth,” said Srikant Dash, head of research and design at S&P, which earns license money from its market-tracking indexes.

The biggest name in the index fund business, Vanguard Group, reached similar conclusions when it examined returns from the bear market’s November 2007 start through December 2008. In that period, 57 percent of managed funds underperformed the broad U.S. stock market, Vanguard found.

Active management’s shortcomings last year weren’t just on the stock side. They also extended to fixed-income investments such as bonds, said Fran Kinniry, head of investment strategy at Vanguard – best known for its stock index funds, but most of the money it holds is actively managed, primarily in bond and money-market funds.

Kinniry argues there’s a lesson in the market meltdown for those who say it’s time to cast aside long-term index investing in favor of more active management and frequent moves in and out of markets. “The most ironic headlines I continue to read say that asset allocation is dead, or ‘buy and hold is dead,’ ” he said, noting that people who thought they could see this coming and make the right moves weren’t rewarded.

So what’s an investor to do? Tom Roseen, an analyst with fund tracker Lipper Inc., said top fund managers have a decent chance of beating index funds in “sideways” markets that are seemingly aimless. Such markets reward investors who manage to latch onto the relatively small number of managed funds that stand out from the pack and post gains.

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