You could build a stairway to the moon and back with all of the research material produced by Wall Street that’s of specious value. The analytical reports that are little more than thinly-veiled sales pieces; the white papers that with 20/20 hindsight thoroughly explain why the most recent market disruption occurred, why it was so unforeseeable, and the lessons have been deeply learned; and the articles that advise that investors should buy this and sell that, which are often swiftly forgotten when those predictions fail to pan out — there is almost literally an unending supply of reading material that investors would be best-served to completely ignore.
But there is at least one exception to this rule — the S&P’s bi-annual Standard & Poor’s Indeces Versus Active scorecard (SPIVA). True, its name would benefit from a marketer’s touch, but it’s one of the very few pieces of research material that can help you become a better investor, because it single-handedly shows just how useless the vast majority of Wall Street’s analytical output is.
The big charade
Such is just part of the kabuki theater that ultimately sidetracks many investors. Fundamental to the show, of course, is the idea that these professionals actually know what they’re talking about, and are capable of outsmarting the market and adding value. Naive investors buy into this charade, placing their bets and hoping they’ve unearthed the next Warren Buffett. When they discover they haven’t, there’s no lack of alternative supposed experts looming, and the chase for outperformance begins anew.
But twice each year, the S&P’s SPIVA report pulls back the curtain and exposes the industry’s would-be wizards for what they really are. For starters, the report shows the percentage of mutual funds that have actually succeeded in outperforming their benchmarks over the trailing one-, three- and five-year periods. The results in the most recent report follow a familiar pattern. In the five years ended June 2011, 61 percent of all large-cap funds trailed their benchmark, as did 79 percent of all mid-cap funds, and 61 percent of all small-cap funds.
The performance is sliced and diced any number of ways — by style, asset-weighted, equal-weighted — but the results are almost inevitably universal: the average actively-managed mutual fund has lagged its benchmark. What’s remarkable is how persistent the pattern is. Eighty percent of international funds trailed their benchmark over the past five years; 87 percent of emerging market funds; 68 percent of short-term government bond funds; 92 percent of high-yield bond funds. The report, in short, consistently paints a rather bleak picture for proponents of active management.
Fund failure rates, and more
But what’s also noteworthy about the SPIVA report is that it also provides a window into a facet of the mutual fund industry that’s rarely reported upon: fund failure rates. The fact of the matter is that hundreds of mutual funds disappear each and every year, with their poor performance record struck from the historical record, invisible to all but the investors who actually suffered through them.
The current report shows that more than a quarter of all domestic equity funds that were in existence just five years ago failed to survive the period. Think about that for a moment: an investor five years ago not only faced long odds in choosing a fund that would subsequently outperform its benchmark, they also faced a one-in-four chance that the fund they selected wouldn’t even be around in five years.
Needless to say, those odds won’t find their way into many conventional Wall Street research reports. The key to successful investing isn’t trying to surf your way across the wave of research that Wall Street generates, trying to capture first this trend and then that one. Happily, the key for investors is much simpler: diversify, keep costs low, and buy and hold for the long term. And by all means feel free to ignore Wall Street’s research that’s almost inevitably urging you to do something; except, perhaps, for that thin little SPIVA report that comes out twice a year, which provides comforting reassurance that ignorance is indeed bliss.