Morningstar Advisor - December/January 2012 - (Page 64)
Gray Matters
Reading the Evidence on Indexing
By John Rekenthaler
In some situations, passive investing strategies should not be an automatic choice, even for advocates of indexing.
There’s no disputing the basic argument for indexing: Dull short-term results eventually lead to sparkling long-term figures. What’s less clear, however, is if and when there are exceptions to the rule. Are there fund categories in which indexing fails? Such discussions tend to be varied—which is not a good thing because many different answers do not mean many different realities. This means, instead, that most observers are wrong. For example, consider the recent and common claim that domestic fund managers have
been badly beaten by index funds during the past three years because U.S. stocks have become more highly correlated. This statement bundles three propositions: Active domestic funds are performing particularly poorly relative to indexes; U.S. stocks are trading more as a block; and a high correlation in stocks confounds the efforts of active managers. The third proposition would be difficult to prove, but the claim fails on the initial premise. It is true that the average diversified U.S.-stock fund has lagged the no-cost Morningstar
U.S. Stock Market Index by 67 basis points per year over the trailing three years (through Sept. 30, 2011), but it leads that same index by 77 basis points annually over the trailing decade. So, by that measure, yes, funds are faring worse than usual.
However, this analysis is inadequate because the index is capitalization-weighted, while the mutual fund average is equal-weighted. This is a problem as the mutual fund average incorporates a style effect, tilting toward smaller companies.
64 Morningstar Advisor December/January 2012
Table of Contents for the Digital Edition of Morningstar Advisor - December/January 2012
Morningstar Advisor - December/January 2012
Contents
Contributors
Letter From the Editor
Seduced by Complexity
Is China Exposure Important for a Portfolio?
A Niche Built on Trust
How to Find Your Client’s Investment Style
Taking the Long View
Consensus on Europe Elusive
Four Picks for the Present
Investment Briefs
Is Perception Reality for Active Managers?
Be Alert for Basic-Materials Bargains
Investment Boom Unsustainable
Digging Moats in China
Where China’s Domestic Companies Stand to Benefit
Arising Opportunities
China Strong Long Term
From Currency Manipulation to International Acceptance
The Keys to China’s Fortune
Wedgewood’s Lessons Pay Off
Reading the Evidence on Indexing
Scouting for Investments Abroad
Yield, Please (Hold the Europe)
Mutual Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
China Fund Managers Eat Elsewhere
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