Active investment management does not work
March 21, 2013
Our recommendation is to drastically change your losing investment approach. There is strong evidence that the time for change is now.
Currently, most investors actively manage their investment portfolios. Some pick specific stocks and attempt to time the market with buy and sell decisions that they hope will produce superior investment returns. Others delegate this investment activity and hire professional managers either directly or through the purchase of mutual funds.
The question today is do you maximize your investment results with conventional active management? The answer in a word is no. Not in the past and not in the future.
We have another piece of evidence showing that many are making mistakes with how they invest. It came in the form of an award to a professor who has proven active buy/sell investment management does not work.
Professor Eugene Fama is a member of the faculty at the University Of Chicago Booth School Of Business. He is known as the father of modern finance. Having published close to 100 academic research papers on finance, he is one of the most cited in the area of economics and finance.
Professor Fama is one of the most highly regarded academics.
He made a presentation to the CFA Institute’s annual conference last year. CFA stands for Chartered Financial Analyst. It is a prestigious designation held by more than 100,000 investment professionals around the world. Most active managers hold this designation.
Holders of the CFA designation are some of the most knowledgeable investment practitioners.
To set the stage there is Professor Fama who has consistently proven active management does not work. He was asked to speak to the experts; the CFA Institute members who manage trillions of dollars of investments and for the most part do this with active management.
Professor Fama said “After costs, only three percent of managers produce a return that indicates they have sufficient skill to just cover their costs”. This means “going forward, and despite extraordinary past returns, even the top performers are expected to be only about as good as low-cost passive index funds. The other 97 percent can be expected to do worse”.
Can you imagine being at that conference and listening to one professor tell his audience of active managers that in effect, they cannot do their job nor will they ever be able to do their job efficiently? It is like a mathematician speaking to a convention of Chartered Accountants and telling them they cannot add or subtract with any success.
For delivering such a scathing research filled presentation challenging and effectively criticizing all who actively manage investments, the CFA Institute awarded Professor Fama the 2012 Best Perspective Award “for the timeliest and most thought-provoking opinion article”.
Professor Fama used the material of the CFA presentation to write an article “An Experienced View on Markets and Investing” that was published in the November/December, 2012 issue of the Financial Analysts Journal.
He also received the 2006 Nicholas Molodovsky Award from the CFA Institute, presented for “outstanding contributions to the investment profession of such significance as to change the direction of the profession and raise it to higher standards of accomplishment.”
The challenge for us is how we use this information to improve investment performance. We suggest a complete review of your investment strategy. Contact your investment advisor and request a meeting.
During the meeting determine if you are an active or passive investor. Ask your advisor to review the difference between the two approaches either from the last four decades of academic research, Standard and Poor’s history of monitoring the success of these two different approaches or just the performance figures of actively managed mutual funds versus the performance of the underlying stock market index.
Make sure you ask your advisor to show that they are using relevant benchmarks for the comparisons.
The second round of questions will be to compare the risks and returns of these two entirely different approaches and the cost associated with this activity. Costs include management fees, upfront and continuing sales fees and tax costs caused because of the high turnover of active management.
Invest wisely. Active management does not work and there are decades of academic research and investment performance as evidence. Be proactive and improve your investing success. The time for change is now.