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Who Routinely Trounces the Stock Market? Try 2 Out of 2,862 Funds<\/strong><\/p>\n When the stock market rose 30 percent in 2013, plenty of fund managers had a triumphant year.<\/p>\n Almost anyone can post good numbers in a bull market, though. It\u2019s like sprinting downhill with the wind at your back: The chances are good that you\u2019ll be pleased with your own performance.<\/p>\n Outperforming most other people consistently, year in and year out, is obviously a much more difficult feat, in any competition. But how rare is it, exactly, for stock market investing?<\/p>\n A new study by S.&P. Dow Jones Indices has some fresh and startling answers. The study, \u201cDoes Past Performance Matter? The Persistence Scorecard,<\/a>\u201d provides new arguments for investing in passively managed index funds \u2014 those that merely try to match market returns, not beat them.<\/p>\n Yet it won\u2019t end the debate over active versus passive investing, because it also shows that a small number of active investors do manage to turn in remarkably good streaks for fairly long periods.<\/p>\n The study examined mutual fund<\/a> performance in recent years. It found that very few funds have been consistently outstanding performers, and it corroborated the adage that past performance doesn\u2019t guarantee future returns.<\/p>\n The S.&P. Dow Jones team looked at 2,862 mutual funds that had been operating for at least 12 months as of March 2010. Those funds were all broad, actively managed domestic stock funds. (The study excluded narrowly focused sector funds and leveraged funds that, essentially, used borrowed money to magnify their returns.)<\/p>\n The team selected the 25 percent of funds with the best performance over the 12 months through March 2010. Then the analysts asked how many of those funds \u2014 those in the top quarter for the original 12-month period \u2014 actually remained in the top quarter for the four succeeding 12-month periods through March 2014.<\/p>\n The answer was a vanishingly small number: Just 0.07 percent of the initial 2,862 funds managed to achieve top-quartile performance for those five successive years. If you do the math, that works out to just two funds. Put another way, 99.93 percent, or 2,860 of the 2,862 funds, failed the test.<\/p>\n The study sliced and diced the mutual fund universe in a number of other ways, too, each time finding the same core truth: Very few funds achieved consistent and persistent outperformance. Furthermore, sustained outperformance declined rapidly over time. And the report said, \u201cThe data shows a likelihood for the best-performing funds to become the worst-performing funds and vice versa.\u201d<\/p>\n What should investors make of these findings? There is one clear implication, said Keith Loggie, senior director of global research and design at S.&P. Dow Jones Indices.<\/p>\n \u201cIt is very difficult for active fund managers to consistently outperform their peers and remain in the top quartile of performance over long periods of time,\u201d he said. \u201cThere is no evidence that a fund that outperforms in one period, or even over several consecutive periods, has any greater likelihood than other funds of outperforming in the future.\u201d<\/p>\n This seems to bolster the case for index-fund investing. After all, if a fund manager with a great year can\u2019t be counted on to outperform other fund managers later, it\u2019s reasonable to ask: Why bother trying to beat the market at all?<\/p>\n A separate series of annual S.&P. Dow Jones studies<\/a> has found that over extended periods, the average actively managed fund lags the average index fund. All of this may be enough to persuade you to abandon actively managed funds entirely.<\/p>\n But the story is more complex than that: The study also demonstrates that active managers can actually beat the market. Remember those two funds that did so consistently over the five years through March? The study didn\u2019t identify them, but at my request Mr. Loggie did.<\/p>\n They were the Hodges Small Cap fund and the AMG SouthernSun Small Cap fund, which were also the top two general domestic funds over the last five years through June, according to Morningstar performance rankings conducted recently for The New York Times.<\/p>\n Each fund has rewarded shareholders spectacularly, turning a $10,000 investment to $35,000 over those five years, the Morningstar data shows. By contrast, the same investment in a Standard & Poor\u2019s 500-stock index fund would have become more than $23,000. While hardly shabby, that\u2019s not nearly as good.<\/p>\n I called the managers of the two funds. Both had good things to say about index funds, and about their own brand of investing.<\/p>\n Craig Hodges, manager of the family-run Hodges Small Cap<\/a> fund, said that index funds are fine for many people, but that the intensive scrutiny his team applies to the often-neglected small- and midcap parts of the market should enable the fund to outperform the overall market in the future. \u201cWe won\u2019t do it all the time, of course,\u201d he said. \u201cWe\u2019ll have bad times. We\u2019ll make mistakes. But over the long run, I think we can keep doing very well.\u201d<\/p>\n Michael W. Cook, the lead manager of the SouthernSun Small Cap<\/a> fund and the founder of the firm that runs it, had a similarly nuanced view.<\/p>\n Index funds deserve to be core holdings for many investors, he said, and despite his own fund\u2019s exceptional record, it may not be a good choice for everyone.<\/p>\n \u201cOne thing you don\u2019t want to do is just read about performance numbers \u2014 ours or anybody else\u2019s \u2014 and put money into an investment,\u201d he said. \u201cChasing past returns doesn\u2019t make sense.\u201d<\/p>\n Asset allocation<\/a> is crucial, Mr. Cook said. Before putting money into a fund like his, he said, ask yourself: Do you really need more small-cap stocks in your portfolio? These smaller companies can be volatile, and they may well decline in price. Janet L. Yellen, the Federal Reserve chairwoman, warned last week of \u201cstretched\u201d valuations for small-cap stocks.<\/p>\n That said, Mr. Cook spoke with the conviction of a true believer about patient, shoe-leather stock-picking discipline. He looks to buy shares in \u201cbusinesses that we can own for a lifetime,\u201d he said. \u201cWe spend a lot of time understanding businesses we buy. And we keep checking them and their competitors and their industries. We need to really understand them.\u201d<\/p>\n Mr. Cook has closed his fund to new investors so that he can maintain control over the portfolio\u2019s quality, he said. If the fund eventually reopens, and you want to consider investing in it, he said, \u201cYou shouldn\u2019t expect that we\u2019ll perform at the very top every quarter \u2014 we won\u2019t do that, I\u2019m pretty sure.\u201d He said that he was happy about the last five years, but that they didn\u2019t prove much.<\/p>\n Over the long haul, which is probably 50 years or more, he said, he will look back at his fund\u2019s track record, and he hopes he will be able to conclude: \u201cWe had a good approach. We worked hard and we did well for investors.\u201d<\/p>\n In the meantime, though, past performance doesn\u2019t guarantee future returns.<\/p>\n How doctors rip off the system:<\/strong><\/span><\/p>\n I used to pay $70 to have wax removed from my ears — three minutes of work.<\/p>\n The $70 was before<\/strong> I went on Medicare and was covered by United Health.<\/p>\n The latest cost was $410, according to the paperwork I got from them.<\/p>\n I called United Health. I thought I might be doing them a favor. They were not interested.<\/p>\n Why should they be? Look at their stock.<\/p>\n Fortunately, it’s on our list. See right hand column.<\/p>\n Ultra stupid, but funny. <\/strong><\/span><\/p>\n Favorite couple of\u00a0 recent New Yorker cartoons:<\/strong><\/span><\/p>\n \u00a0 Super Real Time with Bill Maher<\/em>.<\/span>\u00a0 <\/strong>Last Friday’s episode — July 18, 2014 —\u00a0 was excellent. I especially liked his logic on the Israel \/ Gaza situation. You can watch it on HBGo.com. <\/strong><\/p>\n![\"\"](\"https:\/\/static01.nyt.com\/images\/2014\/07\/20\/business\/20-STRA\/20-STRA-master675.jpg\")
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