Monday, September 04, 2023

The financial industry has so much informational firepower, yet nobody can beat the market. S&P Global tracked the performance of actively managed mutual funds in 2022, a year in which the S&P 500 lost 18%. Even in that environment, 51% of all U.S. large-cap active mutual funds failed to beat the market.

Believe it or not, 2022’s 51% failure rate was great for active managers. The year prior, 85% of them underperformed the S&P Composite 1500 index. And over the past 15 years, only 6.6% of all U.S. large-cap funds outperformed the S&P 500.

Despite their marketing, these funds don’t have a great track record. Keep in mind we’re talking about full-time professionals, working in teams with proprietary research tools, industry conferences, meetings with CEOs, and so on.

Why do they underperform?

One reason is their own rules. Active funds often must maintain diversified portfolios.

If a superstar stock grows to become 3% of the fund, the position needs to be trimmed. So, winners are sold off. The cash buys underweight stocks, which probably won’t perform as well as the superstars.

Diversification is good, but it can hamper returns. Warren Buffett, one of the best investors ever, has always had a highly concentrated portfolio. In fact, his firm’s top five holdings constitute about 78% of the portfolio’s total value.

Unsurprisingly, most stocks don’t beat the market either. An industry study found that since 1990, more than 55% of all U.S. stocks underperformed risk-free, one-month U.S. Treasury bills. These stocks failed to beat cash.

The study also found the $76 trillion in global stock market wealth created since 1990 was generated by the top performing 2.4% of stocks. So, picking winning stocks is like finding a needle in a haystack.