Professional fund managers labor under handicaps that individual investors don’t face. Make sure you manage your portfolio differently than they do.
By Jason Zweig of The WSJ. Excerpts:
"A growing body of evidence shows that fund managers labor under handicaps that individual investors don’t face."
"Consider a new study that looked at the returns of more than 7,800 U.S. stock mutual funds from 1991 through 2020. It measured their returns against those of a market-matching S&P 500 exchange-traded fund and the total U.S. stock market. The comparisons covered monthly, annual and 10-year periods, as well as each fund’s longest track record, within those three decades.
On average, only 46% of funds outperformed the total market over monthly horizons; 39% beat the market over 12-month periods; 34% over decadelong horizons; and a mere 24% for their full history.
Fees are part of the problem, of course. The typical fund charged a bit more than 1% in annual expenses over the period"
"The typical fund returned an average of 7.7% annually over the three decades, after fees. Fund investors, however, earned only 6.9% annually because of their chronic compulsion to chase hot performance and flee when it goes cold.
Such buy-high-and-sell-low behavior tends to flood fund managers with cash at times when stocks have already risen in price—and to force the funds to sell stocks after a decline. The managers can perform only as well as their worst investors allow them to."
"Overall, the study finds, investors sacrificed $1.02 trillion in wealth by investing in funds mostly run by stock pickers instead of buying and holding a market-tracking S&P 500 index fund."
"Total-market index funds consist of about 4,000 stocks, but fund managers have to be choosier than that to justify their fees. On average, actively managed U.S. funds hold 160 stocks"
"nearly all the market’s return comes from a remarkably small number of stocks—giant winners that rise in value by 10,000% or more over the course of decades" (they are called "superstocks").
"less than half of all stocks even generate positive returns over their publicly traded lifetimes, and that only 4.3% of stocks created all the net gains in the U.S. market between 1926 and 2016."
"on average, the fewer stocks a fund owns, the lower its returns."
"Over the three, five, 10, 15, 20 and 25-year periods ended March 31, U.S. stock mutual funds holding at least 100 positions outperformed those with fewer than 50"
"the most diversified funds also earned higher returns than those with 50 to 99 holdings."
"If fund managers could stick to only their best ideas, they might do better. But owning just a handful of stocks could create tax and regulatory headaches—and would expose the managers to massive withdrawals (and loss of fees) if returns faltered.
So most portfolio managers own too many stocks to focus on their best ideas—but not enough to maximize the odds of finding a giant winner.
Individual investors, by contrast, can capture every needle in all the haystacks with a total-market index fund."
"Unfortunately, many individual investors diversify by adding big, household-name companies too similar to what they already own, or by following the crowd into whatever’s red-hot.
Instead, search for superstocks among smaller, unfamiliar firms that have a proven ability to raise prices without losing business."
That last piece of advice is probably easier said than done. But it is still an interesting article.
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