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Investors are turning against stock picking

Investors are turning against stock picking

November 3, 2016

Two critical reasons not to pursue an active strategy in your investment portfolio: it is expensive and it does not work
Two critical reasons not to pursue an active strategy in your investment portfolio: it is expensive and it does not work.

There is a major shift occurring in the investment world that should lead to increased investment returns.

Investors are beginning to appreciate that stock picking, or owning actively traded mutual funds that pick stocks, is a losing proposition.

Those who earn their livelihood from picking stocks will protest loudly, however, the mountain of evidence against that outdated approach is undeniable.

Investors are not able to outsmart the market with a stock picking strategy, so the acceptance of that reality is to migrate investment holdings toward a lower cost, passive management strategy.

Morningstar is a large American firm that monitors investment holdings and investment performance. It has released data that supports the migration of investors from active management to passive strategies.

For the three years ending August 31, investors added almost $1.3 trillion to passive mutual funds. Contrast that significant increase to investor withdrawal from actively managed funds in the amount of more than a quarter trillion dollars.

I anticipate this trend will continue, however, it is interesting to note that most people still own stock picking investments.

Morningstar reported that 66 per cent of mutual fund and exchange-traded-fund assets are still actively managed. While that number is significant, 10 years ago active management accounted for 84 per cent.

Active managers argue that a passive strategy has no chance of providing investment returns above the market average. That point is absolutely correct but also absolutely misleading.

Eugene Fama, The University of Chicago Booth School of Business, is Nobel laureate in economic sciences and often referred to as ‘The Father of Modern Finance’. Kenneth R. French is the Roth Family Distinguished Professor of Finance, Tuck School of Business at Dartmouth College.

In an academic research paper Professors Fama and French reported that only 3 per cent of active managers beat the market over time.

A 3 per cent success rate is very low and to add insult to injury the Fama/French research stated the 3 per cent success rate was a result of luck and not skill.

There are many firms including Morningstar and Standard & Poor’s that provide compelling evidence against active management.

Two critical reasons not to pursue an active strategy in your investment portfolio: active management is expensive and it does not work.

This message against active management is consistent with other columns written in previous years. What is different today is the additional and current information supporting a passive investment strategy.

For those who appreciate taking an evidence-based approach to investing, the evidence is overwhelming. Supported by this current data my prediction is that if you still own actively managed investments, it is likely that will change over time.

Evidence-based investing gives you the best chance of investment success. I recommend you listen to the data.

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