Active Managers Blow Up

October 02, 2008

Someone asked me yesterday if investors should turn to active funds to weather the bear market.


I know all the arguments.  Active fund managers can sidestep the blow-ups in the market, like AIG, Lehman Brothers, Fannie Mae, etc., which indexes must own.  Moreover, index funds stay fully invested at all times, while active managers can hold cash and take protection from the market.

That all sounds nice, but like so much in active management, it falls apart on closer scrutiny.

Tom Lauricella has a great article on this in today's Wall Street Journal. Here's my favorite quote: "In some parts of the mutual-fund world, the performance of actively managed funds compared with indexes has been nothing short of abysmal."

According to Lauricella, approximately 9 out of 10 active midcap funds lost to the S&P MidCap 400 over the past year. In fact, it wasn't even close: the average fund is down 23.2%, while the index is only down 16.7%. Oops.

It's not much better in the other size categories: 80% of small-cap funds trailed the Russell 2000, and 61% of large-cap funds trailed the S&P 500.

The horrible irony of the situation is that, at the same time these funds are handing out losses, they're also getting ready to hand out capital gains distributions. I've seen a half-dozen reports showing that funds have been seller winners to meet growing redemptions, and that shareholders should brace up for capital gains distributions later this year.

If there were ever a better argument for selling out of active funds and moving into ETFs, I'd love to see it.  With most active funds down big, now's a perfect time to do just that.


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