Are active managers getting better and better at their jobs? Yes. Does that mean that it’s getting harder and harder for active managers to beat their own benchmarks? Also yes.
In fact, money managers are getting better, researchers have found. They are better informed, better equipped and often better traders than a few decades ago. The rising level of skill for hire, however, is steadily killing any room that might have existed for differentiation.
The upshot: Increasingly, index investors get a better deal.
Why? Because if everybody on Wall Street has an “edge” and trades in real time, the benchmark itself just moves higher as a result. “As the size of the active mutual fund industry increases, a fund’s ability to outperform passive benchmarks declines,” write Lubos Pastor, Robert F. Stambaugh and Lucian A. Taylor in a new working paper.
Part of the reason is speed of information. We certainly know far more about what’s going on in the world and within the economy, more quickly and more certainly, than we did even 10 years ago. The sheer volume of highly reliable data is truly overwhelming.
Crop prices in India? Live streaming it. Vancouver mining strike? Watching it on video. NYSE stocks? On the phone, desktop, the TV and — eventually — right in some trader’s Google Glass. Data is inescapable, and all that information is now factored into prices, virtually automatically.
Longtime newswire reporters will tell you, the trading action on a stock goes on in the hours before a headline hits. Watch a ticker in real time ahead of a major news announcement. It will wiggle and dance as traders try to outguess what the others have learned or, quite possibly, assumed.
Long investors battle shorts. Hedge funds take no prisoners. Everyone is playing with real money here, and it’s fierce.
Then the news comes out and — bam! the stock price goes flat. The trade is dead and likely to stay dead. The money in play has changed hands and now the jig is up. The exception to this is a surprise headline, an unexpected lawsuit or the sudden dismissal of a CEO. Everything else is factored in well beforehand.
There is more money to manage in the world, it’s true, but that just means there are many more talented, smart people out there trying to manage it profitably. Talent floods Wall Street’s trading desks these days.
The professors continue: “We argue that the growing industry size makes it harder for fund managers to outperform despite their improving skill. The active management industry today is bigger and more competitive than it was 30 years ago, so it takes more skill just to keep up with the rest of the pack.”
The secret
Do you have the money for the fees the best-of-the-best will charge? Can you even get access to those pie-in-the-sky funds? Or are you likely to end up in the “back of the pack” brigade with your retirement money?
Probably the latter, but it’s okay. I’ll let you in on a little secret: You don’t need an active fund manager. You just need a decent portfolio and, for some folks, an advisor who can rebalance it smartly and who has your back when markets wobble.
If you know how to build a risk-adjusted portfolio with multiple asset classes on your own, you can set up a powerful retirement plan at any brokerage in the country using simple, cheap, exchange-traded funds (ETFs).
If you don’t, and especially if the pressure of a changing market and a changing economy might cause you to commit unforced errors, then hiring an advisor can be a good idea. The human touch matters when it comes to your own money.
As for those great returns that the top dogs report, in time you will find that just owning the indexes in a portfolio amounts to the same thing — at a tiny fraction of the cost and stress.
