Hard to beat market

NEW YORK – If you think you can beat the market, you’re probably wrong. And if you think your fund manager can, you’re likely wrong again.

Roughly two-thirds of professionally managed large-cap equity mutual funds are outperformed by the Standard & Poor’s 500 stock index after expenses. The one-third that beat the market in any particular year are just as likely to underperform the market in the next year, according to a study by Burton G. Malkiel, Chemical Bank Chairman’s Professor of Economics at Princeton University and author of the book “A Random Walk Down Wall Street.”

For those still bent on finding funds that beat the indexes, Credit Suisse did a 2003 scouting report with a list of 31 funds whose 10-year returns, from 1992 to 2002, beat the indexes. It also examined what made the Standard & Poor’s 500 as strong as it is.

The strength of the S&P 500 may lie in its simplicity, and its low turnover, according to the report. The committee that picks the S&P 500 looks for stocks with sufficient liquidity and four quarters of positive net income on an operating basis. It looks for the leading companies in U.S. industries. It adds stocks to sectors that are underweighted to better approximate the large-cap market and it drops stocks that would be dropped if the index were created today. Index funds that track the S&P 500 tend to have very low costs.

Funds that beat the S&P 500 had a few things in common, Credit Suisse found. Their portfolio turnover averaged 30 percent, much lower than the industry average of nearly 110 percent. The funds shared a “value” investing style, in which the fund managers buy undervalued stocks. The funds had a high concentration of assets, with an average of 37 percent of assets in their top-10 holdings.

We re-evaluated the funds to see if they’re still beating the index. Of 31 funds in the Credit Suisse report, 19 beat the S&P 500 for the past five years. Nine underperformed and three can’t be tracked.

Looking at the funds that continued to outperform the S&P 500, 10 are closed to new investors, or, in the case of Wasatch Core Growth, to all investors, according to Morningstar Inc. Those funds are Fidelity New Millennium, Janus Small-Cap Value Institutional, Longleaf Partners, Sequoia, Fidelity Low-Priced Stock, Dodge & Cox Stock, T. Rowe Price Mid-Cap Growth, Longleaf Partners Small Cap and T. Rowe Price Small-Cap Value.

Of the remaining, Morningstar has caveats on a few. At Excelsior Value & Restructuring, “Lingering regulatory concerns undermine this mutual fund’s otherwise strong case.” Morningstar also points to “outstanding regulatory issues” at Heartland Value. Morningstar calls Federated Kaufmann K a fund with “flaws.” Of Gabelli Value A, Morningstar sniffs, “Who needs a media, telecom, and industrials fund – practically no one.”

Malkierl’s advice isn’t to chase down the rare fund that beats the market. He writes, “The best stock market investment strategy is to invest in low-cost, low turnover, broad-based index funds.”