Can you pick funds like you pick ponies?
I recently came across a boldly titled article from Ignites, a service of the Financial Times, titled Active Crushes Passive, If You Pick Right . The article reviews studies conducted by actively managed fund families, showcasing the supposed outperformance of certain active managers meeting specific criteria.
One study, for instance, focused on large-cap US funds in the lowest quartile of expenses and from the five largest firms. Unsurprisingly, Fidelity—who conducted the study—happened to have products meeting those criteria that outperformed passive investments. You likely saw that one coming.
What the study conveniently omits, however, is how the majority of actively managed funds—those that don’t meet their narrow filters—performed relative to passive funds. Spoiler alert: they didn’t do very well.
The Study's Flawed Methodology
Tim Cohen of Fidelity argues that most studies analyze the "whole universe" of active and passive funds, drawing conclusions from averages. He suggests that focusing on averages overlooks the story of outperformance hidden beneath the surface.
This argument doesn’t hold water. Any comprehensive study must examine the full dataset to avoid cherry-picking data. Highlighting a handful of active managers as outliers only illustrates the obvious: there will always be outliers on both ends of the performance spectrum.
Imagine a coin-toss competition. Even with 50/50 odds, some participants will emerge with above-average results purely by chance. Similarly, showcasing a few outperforming active managers doesn’t prove skill—it only highlights the statistical inevitability of outliers.
The Fallacy of Outliers
Cohen further claims that in 2015, most assets were concentrated in a handful of high-performing managers, implying that investors can identify and invest in skillful managers. Ironically, this statement undermines his argument, as it highlights the herd mentality and performance-chasing behavior pervasive among investors.
Investors flock to managers with strong historical performance, often based on backward-looking data. Yet countless studies show that today’s outperformers are likely to revert to the mean. When that happens, the cycle begins anew, as the next “great manager” captures attention and inflows. This rinse-and-repeat behavior doesn’t reflect skill; it reflects the pitfalls of chasing performance.
What Really Matters: Costs and Discipline
Cohen does get one thing right: “expenses matter.” Low costs are one of the most reliable predictors of investment success, yet the industry often downplays this fact in favor of promoting active management’s elusive promise of outperformance.
The article’s title, If You Pick Right, suggests that outperformance is possible if investors make the right choices. Unfortunately, this sentiment applies equally to picking ponies at the track or numbers on a roulette wheel. It’s a seductive but ultimately unhelpful approach for building long-term wealth.
Conclusion
Active management studies often highlight the few winners while ignoring the vast majority of underperformers. This cherry-picking, combined with the herd mentality of chasing past performance, underscores why so many investors struggle to achieve consistent results.
Instead of betting on elusive outperformance, focus on what you can control: minimizing costs, diversifying your portfolio, and sticking to a disciplined, long-term plan. These principles will serve you far better than trying to "pick right" in a game where the odds are stacked against you.
Disclaimer: This content is for informational purposes only and is not intended as personalized financial, tax, or investment advice. While we strive to provide accurate and up-to-date information, all investments carry risk, and past performance is not indicative of future results. Any strategies or insights discussed may not be suitable for your specific situation. If you’d like to discuss how this applies to your financial plan, feel free to reach out.