Blake Borgeson, in blog form

We’ve all heard it a number of places over the years, I imagine: actively-managed funds basically never beat the market anymore.  But a study published about a year ago finally sounds like it used the right statistics to answer the question.  It’s covered in this NYT article: The Prescient Are Few.

Here are some excerpts, if you’d rather not click through.

The method:

The statistical test featured in the study is known as the “False Discovery Rate,” and is used in fields as diverse as computational biology and astronomy. In effect, the method is designed to simultaneously avoid false positives and false negatives — in other words, conclusions that something is statistically significant when it is entirely random, and the reverse.

The result:

… when analyzing their entire fund sample, with records through 2006, this proportion was just 0.6 percent — statistically indistinguishable from zero, according to the researchers.

Some likely explanations:

WHY the decline? Professor Wermers says he and his co-authors suspect various causes. One is high fees and expenses. The researchers’ tests found that, on a pre-expense basis, 9.6 percent of mutual fund managers in 2006 showed genuine market-beating ability — far higher than the 0.6 percent after expenses were taken into account. This suggests that one in 10 managers may still have market-beating ability. It’s just that they can’t come out ahead after all their funds’ fees and expenses are paid.

Another possible factor is that many skilled managers have gone to the hedge fund world. Yet a third potential reason is that the market has become more efficient, so it’s harder to identify undervalued or overvalued stocks.

A friendly reminder:

Whatever the causes, the investment implications of the study are the same: buy and hold an index fund benchmarked to the broad stock market.

[thanks to umair haque for including this in ‘Essential Reading‘]