Beating the Market: It’s Still a Tall Order
By MARK HULBERT
Published: January 9, 2010
TRYING to beat the market by buying and selling actively managed stock mutual funds?
You may want to reconsider. Model portfolios recommended by investment advisory newsletters regularly try to perform this trick, but generally fail. Even those that managed to make money during the recent bear market had trouble outperforming a simple stock index fund over an only moderately longer period: the last five years.
That is the finding of a study of nearly 200 model mutual fund portfolios by The Hulbert Financial Digest. These hypothetical portfolios, set up by editors of investment newsletters, used a combination of market timing and sector- and fund-rotation techniques to decide which funds to buy and sell, as well as when to do so. The study took into account redemption fees and front-end loads, or sales charges, as well as the penalties that fund companies sometimes assess for short-term trades.
Consider the model mutual fund portfolio that, of the 200 tracked, made the most money during the bear market of 2007-9: the “Rydex switchers portfolio” of Peter Eliades’ Stockmarket Cycles newsletter. The strategy embodied in the portfolio called for more than two dozen transactions in the Rydex family of mutual funds over those 17 months. One fund that was bought and sold on several of those occasions was the Rydex Inverse S.& P. 500 2X Strategyfund, which is meant to double the performance of the Standard & Poor’s 500-stock index, in the opposite direction.
Mr. Eliades’s model portfolio gained 75 percent during that time — from October 2007 through February 2009 — versus a 50 percent loss for an index fund benchmarked to the broad stock market, like the Vanguard Total Stock Market Index fund. As a result, the strategy beat a buy-and-hold approach by 125 percentage points.
Despite that enormous margin, the portfolio lagged behind the index fund over the five years through December — losing 0.8 percent, annualized, versus a positive return of 0.9 percent for the index fund.
The model portfolio’s erratic performance, of course, constitutes just one example — but was nevertheless more the rule than the exception. It was one of 11 model mutual fund portfolios, of the 200 studied, that actually made money during the recent bear market. Over the five years through December, however, those 11 portfolios gained an average of just 1 percent, annualized.
During the same period, the average actively managed domestic equity fund tracked by Morningstar had a gain of 0.9 percent, annualized, matching the return of the index fund. Those results are statistically indistinguishable from the 1 percent average annualized five-year gain of those 11 newsletter portfolios.
(The best five-year performance, at 4.5 percent, annualized, was registered by the ProFunds/Rydex Sector Rotation Model Portfolio of the Sector Navigator newsletter.)
Why did the model portfolios that did well in the bear market have mediocre longer-term returns? One factor is that many of the advisers who manage them have been predominantly bearish for a number of years, not just during the bear market. Their model portfolios therefore lagged behind a buy-and-hold approach when the market started rising again. From the beginning of March through December, for example, the 11 model portfolios lost 5.1 percent, on average, versus a 56 percent gain for the Vanguard index fund.
Note that, over the last five years, portfolios that made money during the bear market fared no better, on average, than those at the opposite end of the spectrum: the portfolios that actually lost more than the market itself from the October 2007 high to the March 2009 low.
ONE lesson is that performance during a bear market has little to do with long-term returns. Both the best and the worst bear-market portfolios had difficulty beating a buy-and-hold approach over the longer term.
In an interview, Russell Wermers, a finance professor at the Smith School of the University of Maryland, said he has found from years of research that the odds of outperforming the market are very low, even for sophisticated professional money managers using the most advanced techniques. The odds are even worse for individual investors.
Professor Wermers acknowledged that the prospect of beating the market remains a powerful temptation for many people. But the recent bear market may have opened some investors’ eyes, he said.
“If active management doesn’t acquit itself in a five-year period that includes the worst bear market since the Depression,” he said, “then it’s yet more compelling evidence that most investors should not even try.”