Why Mutual Funds are better than Index Funds

[Peter666]

I have heard many people criticize Mutual Funds, especially in comparision to Index funds, citing two main reasons:

-80% are outperformed by the S&P 500
-managment fees are too high

Thus they put their money into index funds. But nobody seems to figure out that the reason most underperform the index is in order to create less fluctuation (variance) for those who want to generate income from their investments (generally older people close to or past their retirement). Most of these people would freak if they saw the swings the indexes take. So the Mutual fund industry is trying to appease the requirments of their clients.

Secondly, there are still the remaining 20% that outperform the market with proven track records and excellent managers at their helm. There are thousands of Mutual funds to choose from, and you should only place your money in a few of the best ones. There are all sorts of books generated on a yearly basis giving the top picks.

Therefore, when you select a mutual fund that has outperformed the index over ten years after management expenses, and with less fluctuation, you have a winner. It is worth the management expense.

If people are serious about making money on the markets, they should not buy index funds. A good value invested Mutual Fund is superior.

[midas]

You need to rethink you investment thesis and match the appropriate index to the mutual fund you are going to buy. If you own a mutual fund that is 100% large cap equity comp that against the S&P 500 index. Most older investors will start to move towards balanced funds that produce dividend income and slower growth (lower risk) which produces uncorrelated returns to the S&P 500.

Most mutual funds managers will try to closely emulate the index that they are comped against and rarely deviate from the underlying securities thus perpetuating the average performance of fund managers. In mutual fund world it's all about the management fees not stellar performance.

[meow_meow]

Meh.
Prior performance is no indication of future performance. The reason actively managed funds underperform index funds is the MER difference, pure and simple.

In the last couple of decades, when the total market returned 10+%/a, a 2% MER was painful but bearable. With the market probably returning <7%/a over the next couple of decades....ugly.

[adios]

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Therefore, when you select a mutual fund that has outperformed the index over ten years after management expenses, and with less fluctuation, you have a winner. It is worth the management expense.

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Could you provide a few examples and the corresponding data?

[adios]

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With the market probably returning <7%/a over the next couple of decades....

[/ QUOTE ]

Interesting comment. What do you base this on and what is your best estimate of the ex ante return on the market?

[player24]

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Most mutual funds managers will try to closely emulate the index that they are comped against and rarely deviate from the underlying securities thus perpetuating the average performance of fund managers. In mutual fund world it's all about the management fees not stellar performance.

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Be careful. Yes, the mutual fund management company earns fees based on assets under management, but the level of assets under management does vary, to some degree, based on the fund's performance. Fund's with strong performance tend to grow faster than Fund's with weak performance, and larger funds generate increased management fees.

Also, the portfolio management personnel at mutual fund companies usually are compensated based on peer group comparisons, not index comparisons. So, a small cap growth fund manager is probably compensated based on his ability to outpeform other small cap growth fund managers. In a given year, all of the managers may outperform (or underperform) the index, but only the managers who perform best will be rewarded...and the managers at the bottom of the ranking will often lose their job (after two consecurive years of underperformance, a manager is usually fired or on probation).

So, mutual fund companies are incented to perform well. And managers have strong incentives to perform well. And 'well' is generally defined by comparing one fund manager to another manager, not by comparing managers to indices.

And, yes, another key reason that funds underperform indices is that the funds are incented to preserve capital in down markets (as the original poster suggested).

[midas]

Interesting, I thought investors evaluated managers on their ability to outperform the no-brainer-low cost alternatives (indexes)which is quite different that how you characterize the internal grading system for a fund family. I guess that's why Stansky at Fidelity Magellan still has his job after underperforming the S&P index for all these years!!!

[OrangeCat]

player24 - Good post

adios - Keep on asking the tough questions.

[BadBoyBenny]

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Secondly, there are still the remaining 20% that outperform the market with proven track records and excellent managers at their helm.

[/ QUOTE ]

I thought only 20% outperform the indexes in a given year. Only a couple have done it for over a decade or so. These also tend to be the funds with higher variance than the indexes, not steadier gains (generally because they have more concentrated portfolos). Bill Miller's teams in the 90's or Peter Lynch's in the 80's come to mind. But as their assets grow, their chances of beating the market are likely to diminish. Index Funds are and should remain the safest way to get the best return for the least work for any equity investor.

[wildwood]

Not to split hairs here, but an index fund is just a mutual fund based on an index. If someone is considering a fund, why wouldn't you want to look at the entire universe of funds? It doesn't seem to me than you gain anything by limiting your options. fwiw

[Peter666]

As I live in Canada, I will give a Canadian example. Our equivalent of the S&P 500 is the Toronto Stock Exchange and S&P composite. Over the last ten years, this composite index has made roughly 9% interest with the worst single calendar year (2002) being at about -14%. A great mutual fund run by Kim Shannon over 10 years has produced roughly 14% interest on average after expenses, with the worst single calendar year (2002) being at 0%.

You can take any type of index fund for any investment style and find at least a couple of superior mutual funds.

For American investing, I like to compare the 40 plus years performance of Berkshire Hathaway to the S&P 500.

An index is simply just that: an index of the average performance of stocks on an exchange for a given period of time. It is a valuable tool in judging the performance of mutual funds and stocks, but I do not know why anybody would invest in an index when there are talented managers providing both less fluctuation and superior return in their mutual funds.

[parttimepro]

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You can take any type of index fund for any investment style and find at least a couple of superior mutual funds.

[/ QUOTE ]
Sure, and if you have a thousand people flip a coin 8 times, one is likely to get all heads. There are enough funds out there that it would be quite surprising if some didn't seem to consistently beat the market.

The real test is whether those funds are more likely than other funds to continue to beat the market. They don't. If you take funds which outperformed from 1993-2003 and compare them to underperforming funds from that period, which would you predict would do better in 2004? Turns out they're about the same.

Luck plays a far larger role in stock picking success than most would like to admit.

[midas]

1. Which fund that Kim manages are you referencing?

2. How do you think a TSE index compares to the S&P 500 index in terms of diversity and market cap of company? You need to make sure you are comparing apples to apples - if you took the top 500 companies by market cap in Canada some would be S&P 500 worthy and others on the lower end would get put in the mid-cap category. If you are looking at mid cap comps you need to compare against MDY in the U.S.

[player24]

[ QUOTE ]
if you have a thousand people flip a coin 8 times, one is likely to get all heads

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yes, and we will put that person's picture on the cover of Barron's and we will write a feature story about his coin flipping technique...and he will explain to us that most coin flippers put too much wrist action into their flips, whereas he ascribes to the view that elbow action is key to coin flipping success...and the public will idolize him for his insight and ability...and he will buy a house in the Hamptons, drive a ferrari and retire at age 40. /images/graemlins/cool.gif

[wildwood]

Hi Peter,
You seem to be saying that a few non-index mutual funds have better performance overall than all index mutual funds based on the premise that Warren Buffett, Bill Miller etc. are some of the top money managers on the planet. But I think you would agree that all non-index mutual funds are not better than all index mutual funds. And we have not mentioned EFT's which are exchange-traded funds based on an index such as oil EFT, nasdaq biotech EFT etc. And then there are country funds such as Spain, Germany etc which are index funds. Certainly there are alot of investing strategies that might include these types of index funds. fwiw

[Peter666]

Hi Midas,

I am referring to the Canadian Investment Fund which she took over in 1995. As it is a large cap value fund (by Canadian standards) I believe the comparison to the composite TSX/S&P 500 is legitimate. You can see all the funds she manages here:

http://www.cifunds.com/web/fund_mgr/mgr_dtl.jsp?lang=ENG&mgrID=52&ltype=T

She uses a mathematical value approach to investing which produces good results whenever she either takes over or starts her own fund. There are other talented managers who do the same in Canada too.

[Peter666]

Hi Wildwood,

I agree with everything you say including that a serious investor should look at and even purchase specialty index funds as part of their portfolio.

The purpose of my post is to show how many have prejudiced themselves against mutual funds, despite the fact that there are a number of them that consistently outperform their respective indexes in both interest returns and fluctuation.

I do not believe (as others assert) that consistently beating the index is just a fluke occurence and gives no indication of future performance.

I also understand that a successful fund will eventually outgrow the market, but one should still follow those managers as they create new funds, and listen to their advice.

Why people would invest in an S&P 500 index when you have Berkshire Hathaway B stocks, or some good mutual fund options is beyond me. Those who have indiscriminately invested in indexes thinking you can't do better are as big suckers as those who have purchased sub-par mutual funds.

[Sniper]

[ QUOTE ]
Why people would invest in an S&P 500 index when you have Berkshire Hathaway B stocks, or some good mutual fund options is beyond me. Those who have indiscriminately invested in indexes thinking you can't do better are as big suckers as those who have purchased sub-par mutual funds.

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You have to remember that the uneducated (with regard to investing) masses may have no desire to educate themselves to find the better opoortunities, that doesn't make them suckers.

Also, even Warren Buffett has been quoted various times as saying that an individual inclined to do their own homework could easily outperform him, as they aren't constrained by the huge size of investments he must make.

[DesertCat]

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For American investing, I like to compare the 40 plus years performance of Berkshire Hathaway to the S&P 500.

[/ QUOTE ]

Don't compare Berkshire Hathaway to a mutual fund. Buffett has never run a mutual fund and never will, as he feels they are greatly handicapped. In fact, don't you realize that Buffett recommends index funds to most investors?

The problem with mutual funds are they are constrained by their size, forced over-diversication, limits on investment types, a shareholder base that forces them to sell holdings at the worst possible times and their high fees and poor incentives.

You don't seem to understand much about Mutual Funds, or you have bought a line of bull that some mutual fund manager has sold you. They don't offer better down market performance. 20% don't beat the S&P 500 over reasonable time periods (5-10 years) it's actually closer to 5%.

And the very very few who do beat indexes over long periods, like Bill Miller, are great investors, but unlikely to repeat that feat because they grow too large and can no longer buy the most attractive stocks. The best ones (Sequoia) have already closed their doors to new investors. In Bill Millers case, he now is forced to buy companies with market caps that are at least a few billion, so he's being forced to buy only in the most efficient and highly researched parts of the market. His record the next ten years ain't going to match the last ten years.

Buffett used to kill the indexes, now he just hopes to beat them. He's dragging a huge anchor of size now. His advantage over mutual funds is he doesn't have to deal with redemptions, and doesn't need to be heavily diversified, and can invest without restriction in many interesting markets (junk bonds, currencies) when stocks are too expensive.

The best structure for investing is a private investment partnership that forces investors to stay committed for long periods of time, and rewards the managers for outperformance, not just breathing. Hedge funds typically have structures like that, though many also have fees that are too high.

As Buffett has said, if you understand value investing, and are a small investor, you should have no problems beating the indexes on your own. If not, buy an index fund.

[Peter666]

First, I don't think you have read all the posts. Second I have provided examples of mutual funds that have soundly beat their respective index over a reasonable period of time. Third, Berkshire Hathaway despite its anchor has continued to cream the market, especially when the market turns ugly.

I agree that a smart investor will develop their own portfolio to beat the indexes, mutual funds and Berkshire Hathaway. But if you have invested in the major indexes like the S&P 500 (not the specialty ones discussed in a different post) thinking they are better than the two alternatives, you are an incompetent investor.

[DesertCat]

[ QUOTE ]
First, I don't think you have read all the posts. Second I have provided examples of mutual funds that have soundly beat their respective index over a reasonable period of time. Third, Berkshire Hathaway despite its anchor has continued to cream the market, especially when the market turns ugly.

I agree that a smart investor will develop their own portfolio to beat the indexes, mutual funds and Berkshire Hathaway. But if you have invested in the major indexes like the S&P 500 (not the specialty ones discussed in a different post) thinking they are better than the two alternatives, you are an incompetent investor.

[/ QUOTE ]

I have read all the posts, amd you have provided only ONE example of a fund that's beaten an index. Whether that fund is well run or just lucky, it's probably not going to beat the indexes in the future over long periods of time.

I described for you in general the handicaps mutual funds have. There are many, many very skilled, very good investors running mutual funds. And 95% of them will trail index funds over long periods of time. It's mainly because of the poor structure aand high costs of mutual funds. In fact, most mutual funds beat the indexes, BEFORE FEES. It's mainly the high fees that cause actively managed funds to trail index funds.

And to repeat. Berkshire Hathaway is NOT a mutual fund. It has no annual fees. It can invest where-ever Buffett wants in what-ever he chooses. That's exactly why it has outperformed. If it was a mutual fund, he would be hard pressed to beat indexes as well.

And lastly, the vast majority of people are "incompetent investors". That's okay, most people spend their time becoming good at something else, usually their careers. They simply don't have the time, education, and patience to invest successfully in the stock market. That's why Warren Buffett recommends they buy index funds.

You seem to think you understand investing well, but you don't understand the basic handicaps your managed fund manager will be suffering from. I think that makes you a good candidate for an index fund.

[Peter666]

How much money does Berkshire Hathaway hold in indexes? If Warren Buffet puts his money where his mouth is, then there is good reason to invest there. But the smart investor will follow his actions before acting on his advice.

Also, nobody said that Berkshire Hathaway is a mutual fund, and if you follow the link provided before, you will see a number of mutual funds trouncing the index thanks to the talent of one manager. The talented managers also realize the inherent weaknesses of a mutual fund, and take that into consideration in their plans. They are not incompetent.

So the bottom line is: follow the example of the proven managers. Invest like they do. But if you don't have the time or the inclination to do that, then pay them to invest your money for you. Do this so long as the net return after fees does better than the index over a reasonable period of time, or at least gives you peace of mind due to less fluctuation.

[Sniper]

[ QUOTE ]
How much money does Berkshire Hathaway hold in indexes? If Warren Buffet puts his money where his mouth is, then there is good reason to invest there. But the smart investor will follow his actions before acting on his advice.

[/ QUOTE ]

Kinda hard for the small investor to buy out a collection of family owned business /images/graemlins/wink.gif

[ QUOTE ]
if you follow the link provided before, you will see a number of mutual funds trouncing the index thanks to the talent of one manager.

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I followed your link to CI Investments... first, their funds are only available to canadians. Second, a quick review of their fund performance list, did not show anything that outstanding. Third, for funds primarily invested in canadian stocks, the S&P500 wouldn't be the appropriate benchmark.

[ QUOTE ]
So the bottom line is: follow the example of the proven managers. Invest like they do. But if you don't have the time or the inclination to do that, then pay them to invest your money for you. Do this so long as the net return after fees does better than the index over a reasonable period of time, or at least gives you peace of mind due to less fluctuation.

[/ QUOTE ]

You continue to disregard the fact that many people do not care to invest the time required to find the best funds/managers. Also, alot of research has demonstrated that the funds that perform best in any one year, and thus get the most cash inflows due to heavy advertsing of their performance, tend to underperform after that.

Bottom line: many people aren't willing to put in the time required to adequately make good decisions about their investments, and thus low fee index funds are a better investment than unresearched high fee mutual funds for those people.

[DesertCat]

[ QUOTE ]
How much money does Berkshire Hathaway hold in indexes? If Warren Buffet puts his money where his mouth is, then there is good reason to invest there. But the smart investor will follow his actions before acting on his advice.

[/ QUOTE ]

I thought I was clear, but one more time. His advice is that if you can invest like Buffett (i.e. you understand value investing), do it yourself. If you can't, do index funds.

[ QUOTE ]

Also, nobody said that Berkshire Hathaway is a mutual fund, and if you follow the link provided before, you will see a number of mutual funds trouncing the index thanks to the talent of one manager. The talented managers also realize the inherent weaknesses of a mutual fund, and take that into consideration in their plans. They are not incompetent.

So the bottom line is: follow the example of the proven managers. Invest like they do. But if you don't have the time or the inclination to do that, then pay them to invest your money for you. Do this so long as the net return after fees does better than the index over a reasonable period of time, or at least gives you peace of mind due to less fluctuation.

[/ QUOTE ]

Thanks for the great examples. All of the Mutual Funds listed in your link have lifetime returns below 10%, i.e. between 7 and 9.8%. The CI Canadian fund has a lifetime return of 8.9%. Vanguard's 500 index fund has a 9.87% ten year return, and a thirty year return of 12.12%.

The CI Canadian manager, Kim Shannon has done a bit better than that over the last ten years (13.3%), but the question is, was she just lucky, or good? Lucky means she had a style that worked well for a few years and pumped up her results. Clearly her last two years have done that for her (20%), in fact they may be the only reasons her ten year performance is above water.

Buying "hot funds" is a recipe for disaster. You buy internet funds after they post 100% gains, just in time to participate in in multiyear 50% losses. You buy momementum funds because they outperformed for three years, just when momentum dies, and they get killed.

If you are convinced that Shannon is actually good, will she stay good? I.e. will the fund grow too large and kill her ability to beat the indexes? What if she quits or retires, or just loses her work ethic? You don't have these risks with index funds.

And if you are right, and she's a great manager who will beat the indexes over time, then she's clearly an exception. 95% of the managers don't, and it's very difficult to weed out the many managers who've had a lucky few years, from the few who will be good for a long periods. So the best advice is, buy index funds.

[Peter666]

I acknowledge your point about ignorant investors. Although I don't see how it is more difficult to read a guide about the top performing mutual funds, then it is to study and understand what an index fund is.

Take it from the perspective of a financial planner: a couple totally ignorant about investing comes into your office asking for the best place to put their money. Would you put them into an index fund or a proven mutual fund? I would put them into a good value mutual fund because I think they would freak out if they saw the volatility in the index. This is due to their ignorance about markets, or just their nature. The longer they keep their money in, the more they will make, and thus the index funds are not conducive for them to keep peace of mind and to keep their money in place. So, that is why I argue that the mutual fund is still better than the index for the ignorant investor.

As for the CI funds, I will provide an explanation below.

[Peter666]

Relative to the Canadian market, the performance of those funds is good. The CI Investment fund has been around since the 1930's. But that was not the point of posting those examples.

The real point was to show how Kim Shannon has improved every one of the funds that she has entered as a new manager. Her record is stellar. She has managed some funds for over 10 years and some for less than five. But whenever she enters one, you see an improvement in the performance. The reason she would enter one to begin with is because it usually was not a good performer. One should judge a fund by its current manager, not previous managers and their respective performance.

Will she stay good?

Well, is there a reason she won't? (Other than outgrowing the market which was discussed earlier)
She uses a pretty simple mathematical system of value investing a la Benjamin Graham. Is anyone going to argue this is not a good way to invest?

Yes, she could keel over of a heart attack, lose her mind, or join the Communist party, but I hope those above her would do something to fix the situation. There are more managers than Kim Shannon, and I am sure they are learning from her.

Above average human intelligence will always beat the mediocrity of the index.

[gvibes]

disclaimer - I didn't read the posts in detail - some things may already have been said.

First, Berkshire Hathaway isn't a mutual fund - I don't know why it is being discussed.

Second, concerning the following statement:
[ QUOTE ]
... Would you put them into an index fund or a proven mutual fund? I would put them into a good value mutual fund because I think they would freak out if they saw the volatility in the index...

[/ QUOTE ]

This is incorrect. Have you heard of "beta"? For instance, Legg Mason Value Trust (as far as I know, the only fund to beat the S&P 500 for each of the last 15 years), has a beta of 1.36. So, the best fund out there is appreciably more volatile than the S&P 500.

So, anecdotally, there doesn't seem to be a whole lot correlation between volatility and returns.

EDIT: actually, if you want to the lowest beta, stick with stocks!!! For instance, brk-a has a beta of ~.14

[Sniper]

[ QUOTE ]
I acknowledge your point about ignorant investors. Although I don't see how it is more difficult to read a guide about the top performing mutual funds, then it is to study and understand what an index fund is.

[/ QUOTE ]

Reading a list of top performing mutual funds and investing based on that has been proven to underperform the indexes over time.

[ QUOTE ]
Take it from the perspective of a financial planner

[/ QUOTE ]

Most financial planners will put you into the funds that pay them the most commission... like non-RB poker affiliates /images/graemlins/wink.gif

[ QUOTE ]
I think they would freak out if they saw the volatility in the index

[/ QUOTE ]

Most funds are just as volatile as the indexes, if not more.

[Peter666]

Hi, I am aware of Beta and discussed this as fluctuation. The mutual funds I deal with have significantly less fluctuation than the index. I am beginning to wonder whether Canadians have been offered much better mutual funds, or if American fund managers are simply incompetent. But I guess that is another topic.

[Peter666]

Now, if Warren Buffet said that an intelligent person who used the value investing style could not only beat the index but also Berkshire Hathaway (and value inveting is inherently less subject to fluctuation than the normal index) than a good value minded fund manager should easily overcome the 2% or so MER and deliver good long term performance. The handicap of huge holdings is much less than BRK anyway. This type of fund should easily beat the index.

PS The financial planner can also get away with overcharging the clients too
/images/graemlins/tongue.gif

[Recliner]

You still fail to see the key problem IMO with mutual funds. Someone can easily outperform the market with a couple hundred million in assests. After that the fund is heavily marketed and people dump in tons of cash so the fund could go from maniging 200 million to 2 billion. Cash flows into the fund faster than it is able to be invested so it sits around earning very low interest rates which will drag the funds performance down in the near future. Then the fund manager is faced with not being able to find enough companies to invest in that will provide for a high return. That cuts down the funds long term performance.

The fund managers are faced with playing split pot poker with a 10% no max rake and only have enough time to play 20,000 hands.

[Sniper]

All mutual funds are inheretly handicapped by the size of their roll, and other rules governing mutual funds. This handicap only increases as the size of their dollars under management increases.

In poker terms, the small limit player has an advantage over the multi-millionaire poker pro in terms of ROI. While the guy with the small bankroll may be able to multiply their roll many times over rolling over fish and collecting bonuses, the high stakes player may have a tough time even doubling up their roll.

[DesertCat]

[ QUOTE ]
Now, if Warren Buffet said that an intelligent person who used the value investing style could not only beat the index but also Berkshire Hathaway (and value inveting is inherently less subject to fluctuation than the normal index) than a good value minded fund manager should easily overcome the 2% or so MER and deliver good long term performance. The handicap of huge holdings is much less than BRK anyway. This type of fund should easily beat the index.


[/ QUOTE ]

I guess you must have some vested interest in selling clients mutual funds (i.e. fees) as you are just not listening.

Buffett has said that a good individual value investor can beat Berkshire's performance. By this he means someone investing only a few million, or maybe tens of millions, but not hundreds of millions.

Buffett does not think this exact same person could reliably beat the S&P 500 if he was forced to invest hundreds of millions or billions in a MUTUAL FUND STRUCTURE! We've told you over and over and over again the problems with this structure.

Clearly Bill Miller is a great example who's an exception to this rule. But he's not very likely to beat the S&P going forward, not with the huge fund he's stuck with. Bill's very good, and he's been very lucky. He is not likely to be both for another ten years.

Buffett has recommended some mutual funds in the past, but those funds are long since closed to keep themselves small and limit the mutual fund handicap on their returns. Buffett no longer recommends any mutual funds, including Bill Miller's. He recommends Index funds.

I'm sorry you don't get as big a fee for selling index funds, but it's in your clients best interest to do so.

[TN_POKER_MAN]

The S&P 500 Index is so top heavy. I don't know the exact figures, but I seem to recall something in the neighborhood of 80% of the index return is dictated by the performance of less than 20% of its holdings.

S&P 500 index funds have underperformed over the past few years because of the lackluster performance of the HUGE stocks out there (Pfizer, AIG, MSFT, WMT, etc.)

In reality, the S&P 500 is not really all that diversified. And contrary to what many feel, index funds are actively managed (who do you think decides on which stocks make the list?).

If you are looking for a Large (mega)cap fund, it's decent, but if you want a diversified portfolio the S&P 500 fund is hardly enough.

[meow_meow]

I'd like to ask OP a question:
What attracts you to post on the 2+2 forums?

After your posts in this thread got a bit strange, I browsed your other posts - no poker content whatsoever.

BTW, my personal favorite is the one where you suggest that homosexuality (or "men boning each other in the bum" as you put it) threatens the continued existance of the species.

So I guess I'm outing you as homophobic, mutual fund-loving, non-poker discussing Canadian.
Ha. I didn't think we had any of those up here...

[DesertCat]

[ QUOTE ]
The S&P 500 Index is so top heavy. I don't know the exact figures, but I seem to recall something in the neighborhood of 80% of the index return is dictated by the performance of less than 20% of its holdings.

S&P 500 index funds have underperformed over the past few years because of the lackluster performance of the HUGE stocks out there (Pfizer, AIG, MSFT, WMT, etc.)

In reality, the S&P 500 is not really all that diversified. And contrary to what many feel, index funds are actively managed (who do you think decides on which stocks make the list?).

If you are looking for a Large (mega)cap fund, it's decent, but if you want a diversified portfolio the S&P 500 fund is hardly enough.

[/ QUOTE ]

Wow. That's a lot of misinformation in a single post. First, you are right that the S&P 500 isn't the best possible index, it's focused on the largest cap stocks. A russell 2000 fund would be better since it exposes you to the broader market.

But index funds aren't actively managed. The indexes are picked on a regular basis (russell is yearly) based on current market caps and liquidity. Berkshire isn't in the S&P 500 because it's relatively illiquid, for example. But the criteria are pretty mechanical.

Managers of index funds do try clever techniques using their cash to earn extra interest to help outperform slightly, but those moves only have a tiny affect. The key is that because their expense ratios are so low (.2-.3%) they tend to match the index results very closely.

And if you think 500 stocks isn't diversified, you and I have entirely different definitions of the word. Certainly it's not "perfectly" diversified, but it's far more diversifed than any actively managed fund I've heard of.

Think about it. An actively managed fund might have 100-200 stocks, and if the fund is large enough, might only be able to buy S&P 500 stocks anyways. So you end up paying the manager 2% a year to churn money around the same universe of stocks.

[Peter666]

I actually do not own any mutuial funds, and do have several holdings in index funds within a universal life policy (I had no choice but to pick several of these within the policy. My real investing strategy is to own a handful of closely monitored and well researched stocks, and they have done very well for me. And of course, this is much better than having money in mutual funds with all their inherent weaknesses.

But when comparing mutual funds to index funds, I still believe that the psychological factor of less downward fluctuation in a proven Value Invested mutual fund far outweighs the consequences of eventually being capped. Thus, a beginning investor will be better served by it. And if you do not agree, than we will have to agree to disagree.

[DesertCat]

[ QUOTE ]
But when comparing mutual funds to index funds, I still believe that the psychological factor of less downward fluctuation in a proven Value Invested mutual fund far outweighs the consequences of eventually being capped. Thus, a beginning investor will be better served by it. And if you do not agree, than we will have to agree to disagree.

[/ QUOTE ]

We don't have to disagree. I would agree that if a fund exists that outperforms the indexes and also is less volatile, it's a pretty good choice.

So show me a mutual fund with a ten year track record of outperforming indexes, and with a lower beta. You seem to think these commonly exist, I don't.

[player24]

The average S&P 500 index fund returned 5.73%, 7.65%, -2.91% and 9.47% for the past 1 year, 3 years, 5 years and 10 years respectively. (annualized annual returns)

The average multi-cap value fund returned 10.73%, 10.08%, 6.22% and 10.14% over the same horizons.

The average mid-cap value fund did even better, where as large cap value funds did somewhat worse. Growth funds did somewhat worse than value funds, but still tended to beat the S&P 500.

These are not the best of the actively managed funds, these are the averages (after fees and expenses - as reported by Barron's in their quarterly mutual fund review, Monday July 11, 2005).

Actively managed stock funds will not always beat the S&P 500 index funds, but they have, on balance, over the past decade. The best performing funds, of course, killed the indices.

[DesertCat]

[ QUOTE ]
The average S&P 500 index fund returned 5.73%, 7.65%, -2.91% and 9.47% for the past 1 year, 3 years, 5 years and 10 years respectively. (annualized annual returns)

The average multi-cap value fund returned 10.73%, 10.08%, 6.22% and 10.14% over the same horizons.

The average mid-cap value fund did even better, where as large cap value funds did somewhat worse.

[/ QUOTE ]

You have some apples and oranges here, like comparing mid-caps to S&P 500 indexes. How well do they do if you compare multi-caps to a Russell index, for example?

[TN_POKER_MAN]

[ QUOTE ]
So you end up paying the manager 2% a year to churn money around the same universe of stocks.

[/ QUOTE ]

no i don't. There are plenty of good mutual fund managers out there that beat the index (even on a net cost basis). I'm sorry, but its about value and not cost.

[player24]

I keep hearing, in this forum, about comparisons between actively managed mutual funds and the S&P 500 - and as soon as someone produces some data which show that actively managed funds have outperformed, the comparison with the S&P 500 is labeled as "apples versus oranges". Most index funds are, in fact, benchmarked to the S&P 500 - broader market indices to not make good benchmarks for passively managed funds (because the funds will usually have to be underweighted the smaller cap names in the index). I own FSTMX from Fidelity - but it is not considered a genuine index fund, for the aforementioned reason.

Never-the-less, I'll play along. ---> Returns of multi-cap value funds were 10.73%, 10.08%, 6.22%, 10,14% over the past 1, 3, 5, and 10 years respectively. These funds beat the S&P 500 index funds in each of the aforementioned periods. Is the Beta of these funds, in aggregate, materially higher than the Beta of the S&P 500? I am not aware that this is the case.

However, making comparisons to the Russell 2000 index, which by design represents small cap equities (many of which are too small to be overweighted in actively managed funds) does not alter the outcome. The Russell 2000 has returned 8.05%, 9.46%, -1.35% and 10.05% over the past 1, 3, 5 and 10 years respectively. It looks to me like the actively managed funds outperformed. (And these are only the averages, the better performing mutual funds killed the indices).

Past performance may not be indicative of future results - but to distort the historical facts (from the recent 10 years) is unwise.

[Sniper]

There are fund categories for a reason!

Small cap and mid cap funds/indexes have a long record of beating the large cap (ie SP500). This goes back to the Law of diminishing returns again. Larger companies just cant grow as fast as smaller ones.

That is why cat said that comparing a multi-cap value fund to the SP500 was apples and oranges.

A smart investor will diverify across capitalization, growth vs value, sectors, international, etc

However, many investors dont take the time to do their homework and therefore the recommedation for them is to stick to an index fund, as the higher performance of other funds also comes with higher volatility.

It is fairly comonly known that a high percentage of people allocate their funds in their 401K in the same manner as the example portfolios presented at their companies 401K info sessions, simply because they figure the guy doing the presenting must know more than they do.

[DesertCat]

[ QUOTE ]
as soon as someone produces some data which show that actively managed funds have outperformed, the comparison with the S&P 500 is labeled as "apples versus oranges". Most index funds are, in fact, benchmarked to the S&P 500

[/ QUOTE ]

Most large mutual funds play in the S&P 500 universe, so that's an apples to apples comparison.

When you choose a Multicap, or MidCap segment, those managers are playing in universe that offers them more and better choices. Their benchmark should be an index across a similar universe.

That said, the numbers you cite are impressive. It appears there now are two small categories of mutual funds (mid and multicap value) that are beating the S&P 500 over ten year periods. As a value investor, I'm not surprised that it's value funds that are doing it.

Note that your numbers indicate these categories were probably trailing the indexes a couple years ago. Results change, and they are now on a heater. Will the two categories be able to beat the indexes in the future? Why not just buy the best performers and assume they'll outperform over the next ten years?

My answer to these questions is that I don't know which ones are good, and which are lucky. I've already written about the problems with managers who outperform for five or ten years but end up with funds that are too large to outperform in the future. With no research you can buy an index and be confident you are going to beat most funds. You will never beat all funds. But you just have to beat the funds that would have been your other choices for it to be a good decision.

[Sniper]

Link to a recent article on this topic...

http://biz.yahoo.com/brn/050713/16266.html?.v=1

[Peter666]

Hi Meow Meow,

I have a cat by the same name. I play Black Jack semi- professionaly and have been vociferously reading Poker books for the last four months. I haven't posted anything about poker yet because I don't have anything worthwhile to say, and all my questions are addressed in old posts.

I'm pissed because of the new gay marriage laws in Canada and the cultural acceptance of a man's hairy anus as a sexually accepted organ. So while the politicians are earning a living legislating this crap, a normal family man has to continue being a wage slave, paying 50% or more in taxes, which makes it unfeasible to have children at a young age, which I want to do. So there.

I don't really love mutual funds, but anything that makes me money while I do next to nothing is a God-send.

[Peter666]

There is a good service at Fool.com called Champion Funds which researches and points out the best mutual fund market beaters.

[meow_meow]

[ QUOTE ]

I'm pissed because of the new gay marriage laws in Canada and the cultural acceptance of a man's hairy anus as a sexually accepted organ. So while the politicians are earning a living legislating this crap, a normal family man has to continue being a wage slave, paying 50% or more in taxes, which makes it unfeasible to have children at a young age, which I want to do. So there.


[/ QUOTE ]

I'm sorry, how is gay marriage connected to your wage slavery again? I must be a bit obtuse.

I can never understand why some heterosexual men fear/loathe gay men, when they should be happy with the reduced competition for heterosexual women.
Wait, I do understand, it's simple, irrational human xenophobia.

[Peter666]

My point about the wage slave thing is that there are incredibly more important things that politicians should be doing instead destroying the last vastages of Christian civilization.

And in terms of reduced competition, the rise of lesbianism negates that.

[Sniper]

[ QUOTE ]
the rise of lesbianism

[/ QUOTE ]

--> Sending 2 lesbians your way.. that should stop your worrying about that real fast /images/graemlins/wink.gif

Getting a bit off topic, fwiw, this is probably better discussed in the politics forum /images/graemlins/smile.gif

[meow_meow]

[ QUOTE ]
My point about the wage slave thing is that there are incredibly more important things that politicians should be doing instead destroying the last vastages of Christian civilization.

And in terms of reduced competition, the rise of lesbianism negates that.

[/ QUOTE ]

Good thing we're a secular society.

[skierdude1000]

mutual funds suck. period.

[popniklas]

Not very convincing. And I think you are wrong.

[skierdude1000]

Mutual funds suck because the returns are way to low.

[Sniper]

[ QUOTE ]
Mutual funds suck because the returns are way to low.

[/ QUOTE ]

This statement certainly doesn't apply to all mutual funds, nor even the average fund.

Fund returns are more than adequate for most people that don't have the time or inclination to do the necessary homework to beat the averages long term.