Is it Better to be Lucky or Smart?
- Tuesday, April 10, 2001
The Christian Stewardship Funds Large Cap Equity Index Fund was launched during May 2000. One could think of better years to start a large cap index fund. The Standard & Poor's 500 Index was down 9.1% for the year and according to Morningstar data, approximately 58% of large cap blend managers outperformed the index. Does last year's returns mean that large cap indexing is past its prime? Those investors who owned the 42% of the funds that did not meet or beat the index returns probably feel otherwise. There are numerous studies that have shown that an index strategy is very hard to beat over time. This is due to the inherent benefits of index fund management: lower expenses, lower portfolio turnover and diversification.
Are there actively managed funds that consistently beat their index benchmarks? From time to time, there appear to be funds that manage to accomplish that feat. If you are fortunate enough to have picked such a fund (which is a very difficult task in itself), was the success due to the manager's skill or was it chance? Some academicians have estimated that in order to determine whether it is skill or chance would require somewhere from 25 to 50 years of returns data from that particular manager. In the article "Performance Games" by John J. Bowen, Jr. and Meir Statman in the The Journal of Portfolio Management, Winter 1997, this issue is also examined:
"If investors make a mistake, it is in giving too much consideration to the performance of particular mutual funds and too little consideration to the average performance of all funds relative to index funds. Judging a fund in isolation from the overall group of mutual funds, we might be tempted to conclude that fund managers who beat their index fund benchmarks six years in a row provide clear evidence of skill. After all, the chance of getting six heads in six tosses of a coin is only one in sixty-four. Once we note these fund managers are among thousands of fund managers, though, we should realize that it is highly likely that there will be lucky coin tossers who get six heads in a row and lucky fund managers who beat the index fund benchmark six times in a row."
Index fund investors don't have to rely on luck. They have lower costs and diversification working in their favor year after year.
Senior Vice President
Capstone Asset Management Company
February 12, 2000
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