Why a Passive Approach Beats Chasing the Latest Hot Stock-picker.

By on December 9, 2011

For over a decade Bill Miller, portfolio manager of the Legg Mason Capital Management Value Trust mutual fund (Value Trust) for 29 years, had been somewhat of a celebrity in investment circles. His claim to fame was that from 1991 through 2005, Value Trust outperformed the S&P 500 Index each calendar year, earning Miller accolades in the financial press and a huge inflow of assets into his fund towards the tail end of this period. Then Value Trust hit a multi-year rough patch in 2006, culminating in a dead last ranking among U.S. large cap equity funds tracked by Morningstar for the five year period ending December 31, 2010. So what does a 15-year winning streak tell us about the investment prowess of an active manager? As it turns out, very little.

Dimensional Fund Advisors (DFA) has recently written an article examining just this question. Their data analysts crunched the numbers and found that over a longer period (May 1982 to October 2011), Value Trust actually underperformed its benchmark by 0.08% per month. More importantly, DFA’s analysis shows that neither the shorter period of outperformance, nor the longer period of underperformance, is statistically significant. So, even twenty-nine years of data is not sufficient to establish active manager skill or lack thereof.

What does this mean for the individual investor? Our conclusion is that investors are better off buying broadly-diversified, index-type funds that capture asset class returns at a lower expense ratio than more expensive, actively-managed funds which offer no proof of superior performance. This is precisely the approach espoused by Dowling &Yahnke since our inception. We build well-diversified investment portfolios for our clients at a low cost and in a tax-efficient manner, using a combination of individual securities and low-expense, no-load funds. This is a proven approach for achieving long-term investment success.

Please click here opens PDF file to read the full DFA article.


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