Active funds are always losers, according to Malkiel


Now should be the time of the actively managed fund. The stock market has recovered from its winter breathlessness, but volatility is still high. A perfect opportunity for stock pickers, right?

Wrong, says Burton Malkiel, the Princeton economist and arguably the founding father of index investing. In his 1973 book, A random walk on Wall Street (now in its 12e edition), he argued that market fluctuations make active investing a wild ride. So it makes more sense to put your money in an index vehicle.

There has been a lot of talk lately that actively managed investments are taking center stage amid the turmoil of jazzy volatility. The popular Robinhood app allows hobbyist market players to trade stocks, commission-free, in search of wealth. “Once volatility sets in, that’s where active strategies can shine,” Matthew Timpane, senior market analyst at Schaeffer’s Investment Research recently told US News. According to research firm Morningstar, active funds beat liabilities during the February-March correction, from 52% to 48%.

Year over year, only about a quarter of active funds beat their benchmarks, as measured by Standard & Poor’s, Morningstar and others. And, since passive funds don’t need to pay expensive portfolio managers, since stock selection simply reflects an index, these funds tend to cost less than active portfolios.

So Malkiel, who is also CIO of robo-adviser Wealthfront, looks askance at predictions that assets will outperform index funds. (The last time this happened was in the dot-com era of the 1990s, which ended badly when the overheated market collapsed.)

“I still like that argument. This is completely wrong, ”he told MarketWatch, referring to the latest prediction of the predominance of active funds. “There is no evidence that due to COVID-19, it is time for active management.”

Among the minority of active funds that outperform passive funds, he said, the list of winners changes every year, suggesting that consistent winners among active managers are rare. Result: Why bother with them? “Those who win in one year are not the same who win the following year,” he said.

He noted with dismay the surge of young investors like Robinhood. “All the evidence is that day traders in general lose money,” he said. “It’s not that they can’t make money playing, I’ve actually won every now and then. But in the long run, this is a losing proposition.

Plus, he allayed fears that index funds, which control half of the equity fund universe, have too much power. Fidelity, Vanguard and BlackRock could crush small investors in corporate votes, the argument goes.

But that’s not happening now, as index funds tend to be too, um, passive, he observed. He called on them to exert more influence. Active managers can still sell, but index providers have a long-term interest in a company’s performance, he said. After all, they can’t sell.

Additionally, Malkiel said he no longer believes in a 60-40 equity and bond allocation as a model for asset allocation in his portfolio. Reason: The interest payment on bonds these days is so small. Instead, he suggested preferred stocks, like those of JP Morgan Chase, which earn 10%. Likewise, he recommended high-dividend-paying common stocks, like those of IBM (5.5%) and Verizon (5%).

Related stories:

World’s largest pension fund steps up monitoring of index investments

Why the index effect is now ineffective

Are index funds really going to take over the world?

Tags: actively managed funds, Burton Malkiel, index funds, Morningstar, Stock market

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