Swedroe: Active Inefficiency Excuse Hollow

June 03, 2015

Even many advocates of active management will concede that the efficiency of the market for U.S. large-cap stocks is so great that attempts to add value (generate alpha) through individual stock selection and/or market timing are unlikely to produce positive results.


However, they cling religiously to the notion that active management remains the winning strategy in less informationally efficient markets. And emerging markets are often considered the poster child for an inefficient market.


It’s in light of this stubbornly persistent belief that Umut Gokcen and Atakan Yalcin—authors of the study “The Case Against Active Pension Funds: Evidence from the Turkish Private Pension System,” which appears in the June 2015 issue of Emerging Markets Review—provide evidence in conflict with the idea that active managers are likely to outperform in inefficient markets.


Lessons From The Turkish Market

As of year-end 2012, the Turkish Individual Pension System had roughly $12 billion (in U.S. dollars) in assets under management. The study data, which is free of both reporting and survivorship bias, comes from RASYONET, a private data provider widely used by the financial industry in Turkey. The study covers the period 2004 through 2011 and includes 157 funds. Following is a summary of the authors’ findings:

  • Even with the majority of active funds setting their own benchmarks, most don’t fare well when compared against their benchmark returns.
  • The average fund underperforms even before fees.
  • Not a single category of funds managed to achieve average performance better than its corresponding index.
  • Even money market funds could boost returns by cutting down on trading, rolling over repos instead.
  • Because the typically used Fama-French size (SMB) and value (HML) factors aren’t available for the Turkish stock market, regression analyses employed the applicable indexes for major asset classes to determine if pension funds were generating alpha (risk-adjusted outperformance). All alphas for equity and bond funds were negative. Money market funds were the sole category t that did generate alpha, and it was very small and not statistically significant.
  • Only about 9 percent of the active managers added value over indexing. However, the top-performing funds in one year weren’t able to repeat their success in the following year, making it unrealistic for retail investors to cherry-pick those few successful managers.
  • If retail investors put half their money into a fund that follows the government bond index and the other half into a fund that follows the stock market index, they would have done better than investing with the top 10 flexible funds (which we would call tactical asset allocation funds).



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