This is another controversial guest column by CFP and CMA Ed Rempel.  Note that this article does not necessarily represent the views of this website.

“We were overwhelming underdogs.” – Yogi Berra

The popular opinion among investors supported by many studies claims that most fund managers underperform their index, so you are better off just investing in an index fund or ETF (Exchange Traded Fund). However, truly “active” fund managers have significantly outperformed their indexes after all fees over the long term, based on a very comprehensive study by 2 Yale academics (Cremers & Petajisto).

We have seen many studies of investing, but this is the most comprehensive and the most informative in analyzing fund manager skill. It identifies one category of fund managers that do beat their index.

There have been many studies comparing mutual funds to indexes, most of which are actually unfair to both sides:

Unfair to mutual funds:

  1. Include index funds among the mutual funds – 100% of index funds and ETFs underperform their index. They are about 10% of funds. But believe it or not, every study we have seen that shows mutual funds underperform actually include all the index funds among the underperforming mutual funds!
  2. Include “closet indexers” – About 30% of mutual funds try to be similar to the market, since this tends to make investors in those funds comfortable, increases the sales of the fund and tends to preserve the fund manager’s job. Most are trying to be close to the index and are arguably not really trying to beat it. How can you expect to beat the index if you have costs of managing your fund (MER of 2-2.5%) and similar holdings to the index?
  3. Include conservative funds – Many mutual funds don’t even try to beat the index. Because many investors cannot tolerate index level risk, a lot of mutual funds try to be less volatile than the index. For example, of the pure Canadian equity funds, 232 are less volatile than the TSX, while only 76 are more volatile. Leaving a margin for error, 23% of funds (74 funds) are between 10-40% less volatile than the TSX. Are these funds even trying to beat the index?
  4. Include the cost of advice – Most mutual funds pay your financial advisor for comprehensive planning advice (whether you get it or not). With index funds or ETFs, you would have to pay extra if you would benefit from advice or a financial plan. A fair comparison should exclude the cost of advice that is built into the cost of mutual funds.

Unfair to index funds:

  1. Exclude closed funds – Using today’s data has a “survivorship bias” because this excludes funds that closed down. Funds are closed for a variety of reasons, but the most common reason is that the fund was unpopular, so closed funds were more likely underperformers.

I recall a night playing cards with several couples when I realized that all the guys were playing to win, but all the women were really just playing haphazardly and enjoying the company. The game is very different when half the players are not really even trying to win!

That is what the comparison of mutual funds to index funds is like. Depending on what you include, only about 40-60% of mutual funds are actually even trying to beat their index.

Our view is that any study trying to meaningfully measure the skill of fund managers should exclude at least the 40% of equity funds that are index funds or closet indexers, and possibly those that are much more conservative. These studies should only include funds that actually try to beat the index!

Active Share

The Yale study introduced the concept of “Active Share” – the degree to which a fund’s holdings differ from the index. It is a scale from 0-100%, where 0% means it is a passive index fund identical to the index, and 100% means the holdings have no overlap from the index.

They found that among “stock pickers” – funds with an Active Share of 80-100% – the average fund beat the index by 1.5%/year after all fees for the entire 13-year period of the study. Meanwhile, funds with an active share of 0-20% underperformed the index by nearly 1.5%/year.

This is an important point. The conclusion of this very in-depth study was that, once you filter out the index funds and closet indexers, the average mutual fund beat the index by 1.5%/year for 13 years after all fees!

The graph of the results shows clearly a surprising fact – the more different a fund is from the index, the better it tends to perform!


We think that the reason for this is that only a smart, skilled fund manager has the confidence to be completely different from the index.

Looking for funds very different from the index is a great filter to help identify the most skilled fund managers. Those unlikely to outperform will identify themselves by having holdings similar to the index.

Fund managers that are focused on keeping their job by being similar to the index, that have bosses telling them what to do, that make their top 10 holdings look good for investors especially at month-ends (“window dressing”), that want to own popular stocks, and generally are focused on having a fund that people will buy – will want to own companies with big, recognized names. They will want to avoid losing money when others are doing well by having similar holdings and sectors to the index.

We call this the “business of investing”. Fund managers from the “business of investing” will filter themselves out. By focusing on making their fund popular, they will have a low Active Share and little chance to outperform.

However, fund managers that are focused on getting the best possible return with a given risk level, the true, skilled stock pickers that are passionate about researching companies, that are confident in their methods, and that have most or all of their own money in their fund – will want to invest in the undiscovered gems they find and the companies they believe are the most undervalued or the fastest growing.

We call this the “profession of investing”. Fund managers from the “profession of investing” invest like they would invest their own money. By focusing on being the best possible investor, they have the best chance to outperform. The Yale study shows that the average fund in this high Active Share group does outperform – after all fees.

Being very different from the index means there will obviously be times when they will lag while others are doing well, but, and this is the key point – it is necessary to be different from the index if you want to beat it.

In our search to find “All Star Fund Managers”, there are many important factors, but one important criterion is that they must be quite different from the index – which means they will have a high Active Share. It is not easy to identify the truly skilled fund managers, but Active Share is one objective measure that is a good start.


What can we learn from this study?

  1. Be Different – The more different your fund is from the index, the more likely it will outperform.
  2. Avoid “closet indexers” – If the top 10 holdings of your fund include more than 1 or 2 of the top 10 holdings in the index, you may have a closet indexer. You would need to look at the holdings more closely to be sure. With a closet indexer, you are paying the full cost of a skilled fund manager, but you have little chance to outperform. Most closet indexers are from the “business of investing”, which means they are focused on having a fund that will sell, instead of focusing on good performance. Our view is that nobody should buy a closet index fund.
  3. You can get comprehensive advice for free – Even if your fund doesn’t beat the index, but just has similar returns, you may be way ahead. If you would benefit from comprehensive financial advice (and almost everyone would), your mutual funds already pay your advisor. If you own “No advice investments”, such as stocks, ETFs or low cost index funds, you would have to pay extra for advice. If you are paying for advice, you should insist on getting it. Admittedly, the advice from many financial advisors may not be worth paying for, but the #1 reason given by advisors for NOT doing a comprehensive, written financial plan for clients is that “they don’t ask for it”. If you own mutual funds, insist on getting the comprehensive advice you are paying for!
  4. “All-Star Fund Managers” do exist – Most are from the “profession of investing” by focusing on being the best possible investor. They have the confidence in their discipline to be completely different from the index or from currently popular stocks. Active Share gives us one objective measure to help identify them.

You can read the complete study here.

About the Author: Ed Rempel is a Certified Financial Planner (CFP) and Certified Management Accountant (CMA) who built his practice by providing his clients solid, comprehensive financial plans and personal coaching.  If you would like to contact Ed, you can leave a comment in this post, or visit his website  You can read his other articles here.


  1. Steve on July 6, 2010 at 10:24 am

    I agree with Ed that when evaluating mutual funds as far as ‘beating the market’, every fund in the evaluation should have a goal of beating their benchmark index. If that’s not the goal, don’t include them.

    Really, a mutual fund is a product with a goal (prospectus). Whether it is a good product is simply whether they meet that goal sufficiently often.

    Index funds have a goal of matching their index as closely as possible. I would say that most index funds meet their goals, therefore you don’t need a crystal ball to pick the right ones.

    The problem with Mutual Funds that do have a target of beating the market, I don’t believe enough of them succeed such that you can pick the right ones based on conventional research. In other words, you need a crystal ball to pick the right mutual funds that will achieve their goal of beating the market.

    If I had a crystal ball, I’d just pick the stocks that go up and beat the heck out of the market.

    It seems to me that investors seeking capital gains should still go with index funds because the risk of choosing the wrong mutual fund is too high for the small gain you get by beating the market.

  2. Houska on July 6, 2010 at 10:30 am

    Very interesting study, Ed. Thanks for sharing.

    Some of the big questions I have not answered by this study
    – How wide is the variation in the performance premium for each quintile? With just the averages, it leaves tantalizingly unanswered to what extent going with an actively managed fund pays off if and only if you bet on a winner, vs true in a broad range of choices
    – How sensitive are the results to the time period chosen?(I think their data is 1990-2003 – includes both some up and some down periods, but does leave me wonder to what extent the results are explained by saying “in the tech bubble it was a bad idea to have followed the tech herd” – but maybe I’m overly swayed by the role Nortel played in Canada)

    I draw the following conclusions
    – There is evidence that on average/some/in some cases true active managers exist and can sustainably manage better than just indices
    – Investing in funds that more or less mimic the index is not worth it – either choose active management, and then be willing to pay for it, choose carefully, and choose someone who doesn’t follow the herd; or choose indexing, and then do it cheaply. Don’t pay a premium for closet indexing.

  3. Money Smarts Blog on July 6, 2010 at 11:29 am

    The study was quite interesting – I love the idea of evaluating funds with higher Active share separately from closet indexers, although it was really hard to understand their exact methodology.

    I’m not sure if the writer actually read the report or not, but I don’t see anywhere in the results that indicates that the most active quintile of funds outperforms their benchmarks by 1.5% after fees.

    In fact it says:

    Funds with the highest Active Share exhibit some skill and pick portfolios which outperform their benchmarks by 1.51%-2.40% per year. After fees and transaction costs, this outperformance decreases to 1.13%-1.15% per year.

    Those numbers (1.51%-2.40%) are before fees (MER and trading fees). If you consider that most mutual funds in Canada charge 2%+, it’s hard to see exactly how this “outperformance” will benefit the investor.

    If anything, this is still a great argument for keeping your costs low. If you want active management, then a low-cost shop like Steadyhand will give you a much better chance of outperforming than a high-cost “superstar manager”.

    A couple of other nitpicks:

    The study was from 1980-2003 so it’s actually a 23 year study, not 13 years.

    “Active” is spelled wrong in the title.

    • FrugalTrader on July 6, 2010 at 11:34 am

      Thanks for the heads up Mike, fixed the typo!

  4. tom on July 6, 2010 at 11:53 am

    Where would you find lists of “Active Share” when shopping for mutual funds?

  5. Money Smarts Blog on July 6, 2010 at 12:08 pm

    Tom, I doubt anyone measures “Active Share” on an on-going basis.

    The method I’ve seen to identify non-closet indexers is to look at the coefficient of determination. It’s not the same as “Active Share” but the number is available.

    This article explains how to find it:

  6. Aolis on July 6, 2010 at 12:11 pm

    I really hope that Ed Rempel paid you for this opportunity to market his “professional services”.

    He starts off with a a study that just happens to be posted on his professional website. He concludes from it that we should look at funds that are different from the index. The study actually states, “We find significant dispersion along both dimensions of active management.” While the average fund might have done better than the index, each particular fund could have done very well or very badly.

    Is Ed Rempel suggesting that we should buy a large number of mutual funds, perhaps weighted according to an index of Active Share? This is exactly what index investing is all about. Buy a number of different shares in different companies so that you can get the average return of the market since it is impossible to predict which company will do well.

    In the second half of the article, Ed Rempel goes on to draw conclusions that have nothing to do with the study. He starts talking about the “business” or “profession of investing” and that there exists a mythical “All Star Mutual Fund Manager” that he can magically identify, if only you agree to pay two to three percent of your savings every year (average Canadian mutual fund MER).

    There is no evidence for these conclusions, especially point four. It is simply a marketing slogan used to attract customers. I don’t see many studies posted on his website discussing the benefits of index investing.

  7. mode3sour on July 6, 2010 at 12:39 pm

    Interesting write up but it fails to convince me mutual funds are not a huge rip off. I especially don’t want to pay 2-3% and to take a gamble on getting an elusive “All-Star” rather than one of the many not even trying to beat the market.

    If your goal is to underperform the market and it costs 2-3% what’s the point.. Better off with GICs then

  8. Andrew F on July 6, 2010 at 5:31 pm

    It’s not strictly true that every index fund always underperforms the market. There can be positive tracking error, in which case a fund can slightly beat the index. Most of the time, it will do slightly less than match the index, after fees.

  9. Thicken My Wallet on July 6, 2010 at 6:56 pm


    The study states Active Share funds beat the benchmark NOT the index. Since mutual funds have relative return basis which is not pegged 100% to a broad based index the passage:

    “…. The conclusion of this very in-depth study was that, once you filter out the index funds and closet indexers, the average mutual fund beat the index by 1.5%/year for 13 years after all fees!”

    is actually one step too far from what the study stated since it does not necessarily follow outperforming a mutual fund benchmark is outpeforming the index.

  10. Houska on July 6, 2010 at 7:29 pm

    Boy, some of these comments are pretty harsh on Ed! Is there a potential conflict of interest here – definitely. But since this and other Canadian blogs generally make indexing a core part of their philosophy, you could equally well complain about COI anytime they comment on the perils of active management.

    I’m not going to re-skim the report again but many of the key numbers in the report (I didn’t cross check them against Ed’s synopsis) are *net* of fees (except front and back load).

    I agree with the posters saying (in different ways) that the conclusions are hard to act on without knowing the dispersion of returns for each quintile, not only the averages.

    Beyond that, they also highlight the perils of paying a management fee (which might or might not be worth it for good active management), but getting only closet indexing, or indexing plus mediocre half-hearted active menangement only, in return). Far too many retail investors in Canada do this.

  11. Multiple Egg Baskets on July 6, 2010 at 10:50 pm

    Hey, I love the directness and not trying to sit on the fence! One question though: what is the validity of your statement in relation to long term historical trends? Does it support your opinion?

  12. Ed Rempel on July 7, 2010 at 12:06 am

    Hi Steve,

    One of the main points of the study is that you don’t need a crystal ball. Funds with high Active Share tended to keep it and tended to outperform. They specifically stated that choosing funds with a high Active Share is a good way to predict which funds will beat their index.

    Also, of the funds in the highest category, the AVERAGE fund beat the index.


  13. Houska on July 7, 2010 at 12:50 am

    Ed – I think in #13 you are overstating the conclusion. On average, funds with high Active Share tended to keep it (yes) and on average outperformed. That is not the same as “tended to outperform”. I’d love to see the histogram of performance vs benchmark for each quintile. My hypothesis is that the histogram is narrow and somewhat negative for the “Closet Indexer” type categories, and broad for the High Active share. But in terms of drawing conclusions it is hugely important to know whether the High Active share higher average is due to a high degree of spread with e.g. some high positive outliers, or if it is a general biasing upwards of the histogram without getting too much wider. In the latter case, it is a reasonably powerful argument for going for active management. In the former, it just says active management is a bit of a lottery, and says you should not go for closet indexing (i,e, if you want to index, do it cheaply)

  14. Ed Rempel on July 7, 2010 at 1:04 pm

    Hi Houska,

    You raise some good points in #2 & #14. The distribution of the returns for the high Active Share fund managers was quite wide. The study answers the question with statistics, but not an actual distribution.

    In short, the returns of the high Active Share fund managers was quite different from the index – a relatively wide distribution. On average, they top group’s returns averaged 6-8%/year different from the index, with most of these returns being higher.

    It is a bit complex to explain, but of the 694 fund managers with an Active Share of 80-100%, the largest group (245 of them) had a standard deviation of their returns of 6-8%/year different than the index.

    That explanation may not be too helpful, but that is the interpretation from the study. This means that 2/3 of the time, the high Active Share fund returns were 6-8%/year different from the index and 1/3 of the time they were more different than that.

    To try to explain the concept, this doesn’t quite mean they beat the index by 6-8%/year. These were the funds that mostly beat the index, but their returns were typically 6-8% different from the index each year (some lower and some higher, but mostly higher).

    It is also interesting that the period of the study from 1990-2003 includes both the tech boom and the tech bust, as well as the 1992 recession, the “Asian Contagion” and a few other unique market events.

    I doubt that the tech boom and bust affected these results, though. They used only broad-based funds (not the sector funds) and they filtered out many possible explanation factors, which would imply the they would likely get similar results with other periods of time.


  15. Ed Rempel on July 7, 2010 at 6:36 pm

    Hi Money Blog,

    This study has actually been published several times with small revisions in the results.

    The original (I believe) version was published in 2006 and showed the fund managers with the top 20% Active Share beat their index by 1.39-1.49%, while the bottom 20% underperformed by 1.41-1.76%.

    The latest version is the one we just put onto our web site that shows the top 20% outperforming by 1.13-1.15%, while the bottom 20% underperformed by 1.42-.1.83%.

    All these figures are after all fees.

    We tried calling them and talked to one of their research assistants for an explanation. Apparently, it is common with university studies to publish updates based on their latest knowledge. They say it is a slight change in methodology, not any change in the data.

    The 2 different numbers are not a range. The first number (1.13%) is just the amount the average fund manager in that category beat the index by. The second number (1.15%) is a formula calculating Alpha based on 4 factors. Alpha is a statistic measure of “manager value-added”.

    The study specifically looks at MER and does not show an advantage for low fees, except for index funds and closet indexers (of course). For the managers with high Active Share, the fund managers with the highest Active Share actually had slightly HIGHER MERs – not lower.

    This makes sense. They are truly active fund managers and more than justify their higher fees.

    The study has data for 23 years, but the fund analysis is only for 13 years from 1990-2003. The reason for this is that nearly all funds were truly active back in the 1980s. They wanted to compare high Active Share to low Active Share funds, but there were hardly any low Active Share funds in the 1980s.

    In the last 20 years, many people have come to the mistaken conclusion that nobody can beat the index. This seems to have led to a deterioration of the quality of fund managers, with 30% now being closet indexers.


  16. Paul on July 7, 2010 at 6:38 pm

    Warren Buffet and Bill Gates have 1.9 billion of this stock?

    What stock is this?

  17. Ed Rempel on July 7, 2010 at 6:45 pm

    Hi Money Blog,

    By the way, we just found out that Cremers and Petajisto are now working on 2 new papers – one with US data through to the end of 2009 and one with data on Canadian funds.

    We are really looking forward to those. We are speculating on the Canadian results. We have higher MERs in Canada, mainly because they include the cost of advice here, so can fund managers make that up? We also believe that the percentage of closet indexers is probably much higher in Canada. It is hard to find a fund that does not have several of the big banks and the largest insurance, gold and oil companies in their top 10.

    The TSX is also not diversified, which should make the results interesting. The hottest sectors lately have been the banks and resource companies that make up 80% of the TSX. In the late 90s, the TSX was mostly technology, with Nortel actually making up 48% of the index by itself at the peak. So, the index rode the hot sector both up and down.

    The Canadian results and the updated US results, including 2008 and 2009 (the worst and one of the best years in 80 years), should both be interesting!


  18. Ed Rempel on July 7, 2010 at 6:54 pm

    Hi tom,

    For now, the Active Share results of specific funds is not public information, although we have it for most of our fund managers. S&P and MSCI charge fees for the detailed index data that you would need.

    You can estimate it by looking through the holdings and comparing them to the index. Funds publish their detailed holdings only once or twice a year, but you can see the top 10-15 every month, which can at least give you a clue.

    We have heard that Morningstar might start including Active Share in their data later this year, but that is not confirmed.

    Most of the tons of data produced about mutual funds is not very helpful in identifying the top fund managers, so adding Active Share would be helpful.

    High Active Share alone does not tell you that you have an “All-Star Fund Manager”, but it can be very useful in ruling out all the closet indexers.

    We think that the best benefit of publishing Active Share stats would be that the public could become educated and stop buying closet indexers!


  19. Ed Rempel on July 7, 2010 at 7:13 pm

    Hi again Money Blog,
    The “coefficient of determination” is similar to “tracking error” that is identified in the study. Both are essentially a correlation of the movement of the fund compared to the index. However, this study found that it is not helpful in identifying outperforming fund managers.

    This stat is publicly available on Morningstar, etc. and can help you identify funds that might be closet indexers, but the study showed that funds with a high “tracking error” did not outperform funds with low “tracking error” or their index the way funds with high Active Share do.

    Index funds and the most blatant closet indexers did have a low tracking error, so you can identify them. However, most of the closet indexers did not track quite that closely.

    The difference is that Active Share compares the fund holdings to the index, while tracking error and coefficient of determination measure correlation.

    Where this makes a difference is that:

    – Funds with similar holdings to the index but focused in different sectors tended Not to outperform, but still have a low correlation to the index. The study called these funds “factor bets”. They are essentially sector market timers, which seems to be a strategy that does not work.
    – Funds with more holdings, but very different from the index tended to outperform, but still be more closely correlated to the index. The study called them “diversified stock pickers”.


  20. Money Smarts Blog on July 7, 2010 at 7:27 pm

    I’ll be looking forward to the Canadian results.

    The problem with the net fees in that report is that they are for American mutual funds which have much lower fees than in Canada. You just can’t ignore that.

    The “net of fees” results in Canada will likely be much lower.

  21. Ed Rempel on July 7, 2010 at 7:34 pm

    Hi Aolis,

    We just added the article to our web site so that we could make sure we had a reliable link from this blog for anyone that wanted to read the original study. But we did find it very useful.

    Active Share does not by itself identify a top fund manager, but it can help you rule out those that are not.

    Think of it like being a great skater in hockey. An all-star hockey player will most likely be a great skater, so you can rule out most of those that are not great skaters, but just because someone is a great skater does not make him a all star.

    This study was very comprehensive and clear shows that some fund managers CAN predict which companies will do well.

    The belief that nobody can beat the market is rampant, but makes not sense to us and does not fit with what we observe in studying fund managers. I can also identify the top people in many other fields, especially areas that publish a lot of stats – like sports.

    Granted the markets are much more complex than hockey, but I can tell you who most of the most talented hockey players in the world are. There are people with superior talent, intellect, and work ethic in every field.

    Why do people think that would not also apply to investing???

    For example, the market is very manic with most investors, including most professionals, being sheep – essentially following the herd. This creates large systematic mispricings, which is why the majority of the all-time best fund managers are value style. There are many styles of investing, but one style has most of the top investors.

    The top investors, not surprisingly, are not sheep, and are not following the herd. This study just confirms what makes intuitive sense to us – the top investors have holdings very different from the index.


  22. Ed Rempel on July 7, 2010 at 7:42 pm

    Hi Thicken,

    This study actually proves the top funds do outperform indexes, not just “benchmarks”. It compared every fund to 19 different indexes and used the one that it was most similar to. So, it did not accept the fund’s category or benchmark.

    This study compares every fund to a specific index – whichever index of 19 the fund most closely resembles.

    The benchmark for a mutual fund is always an index or a combination of indexes, but this study was far more in-depth than to just accept their benchmark.

    This is just one example of how in-depth the study is.


  23. Ed Rempel on July 7, 2010 at 8:19 pm

    Hi Houska & Multiple Baskets,

    Thanks for the support!

    I’m just trying to provide some general education. Too many people believe all the index propaganda that nobody can predictably beat the market and too many people buy closet indexers!

    Your question about whether this will hold long term is interesting. We think so.

    The study did show that fund managers with high Active Share tended to continue to have it in the future. This makes sense. A good stock picker that has holdings very different from the index is unlikely to suddenly have very similar holdings in a future year, except for possibly the odd year.

    Our experience with what we call “All-Star Fund Managers” is that the all-stars tend to remain all-stars. In fact, our experience agrees with the study that experience makes a big difference.

    Wisdom (for lack of a better word) makes a big difference. Young fund managers usually get into heavy computer analysis of public information, graphs, and many ideas that sound logical, while the more experience fund managers learned years ago that most of these don’t work.

    Having said that, all top fund managers also have significant periods of underperformance. I saw one article that listed the top fund managers since 1950 and the percent of the time they underperformed. Most underperformed about 30% of the time and still beat their index by wide margins over the long term.

    One striking example is Rick Guerin who managed a fund from 1965-83. This was a very unfortunate time – the period of time many people wrongly claim the index had no growth at all.

    He beat the index by 32.9%/year compounded during his career! And yet, he underperformed the index in 7 of 19 years (37% of the time).

    Having a high Active Share means you are very different from the index, so it inevitably means there will be periods of underperformance. This is part of why All Star Fund Managers are not that easy to identify.

    Our big question is whether this fact will result in periods of time when an updated Active Share article would not confirm outperformance. The updates from the existing study already show the degree to which the top fund managers beat the market goes up and down.

    In general, though, we would be surprised if future studies would not continue to show that top Active Share fund managers generally would beat their index.


  24. JFG on July 7, 2010 at 10:27 pm

    It’s all about the manager.

    Remember the Altamira Equity fund of years passed? The darling of wall street and it put Altamira on the map.

    What about AIC? That fund was untouchable. Didn’t he sell his company?

    PH&N. Now that RBC has them, will they still perform?

    Sorry, but Mutual Funds are quite dependent on the Manager and if the Manager leaves, then what?

    I’ll stick to my ETF’s, thank you.

  25. why I opened an ING account on July 8, 2010 at 1:12 am

    JFG: Very true, I’ll keep to ETFs too.

  26. Houska on July 8, 2010 at 1:35 am

    @JFG (#25) – tautologically true. If you’re buying active management, you’re betting on the manager. If the manager leaves, you’re either making a bet on his/her (are there many hers?) successors or you should move on.

    @Ed (#24) – I’ll read your #15 in more detail in the morning. In the meanwhile, your #24 and Canadian Capitalist’s blog entry today on Legg Mason make me wonder: did the study correct for level of market risk (beta) and level of volatility overall? One of the ways institutional investors sometimes claim to generate alpha (which is effectively what this study is saying about the active retail market) is by actually taking on more risk. You would expect more risk to mean more return, so if the High Active Share funds are also on average more volatile than their benchmarks, one could presumably duplicate the effect by biasing ones’ asset allocation and yet staying a passive (index) investor.

  27. Ed Rempel on July 8, 2010 at 2:48 am

    Hi JFG,

    In our opinion, most of the managers you mentioned were just the aggressive manager in a hot sector. They were temporarily industry darlings (as you put it), but that is completely different from being an All Star.

    What is so scary about a manager leaving? It’s like having Sidney Crosby on your team. What if he leaves? Just find someone else.

    There is a deeper point here, though. The most skilled fund managers almost never leave their company. The reason for this is that top fund managers are rarely employees of someone else’s company. It is far more lucrative to have your own investment firm and get contracts managing certain funds, or have a fund company create a fund for you.

    All Star Fund Managers, in our opinion, nearly always own their own firm, so they never leave it. Even when the retire, in some cases they have a good succession plan and the firm continues to outperform the same way.

    Having a manager leave has almost never happened to us and is not something we worry about.


  28. Ed Rempel on July 8, 2010 at 2:56 am

    Hi Houska,

    Of course they took risk level into account. The 2 figures showing the amount by which the high Active Share fund managers beat their index are not a range. They are 2 different methods. The second figure (1.15% outperformance) is based on Alpha, which is “manager value added” taking into account risk level.

    The study found that adjusting for risk did not change the results.

    There is a follow-up article to come shortly that explains more details from the study. It lists a bunch of the factors that they all adjusted for, such as risk, size of holding, size of fund, etc. My first thought was that perhaps they were buying small caps, but they allowed for that as well.

    The study clearly shows that these are superior stock pickers. They beat the market without more risk.


  29. JFG on July 8, 2010 at 10:56 pm

    Actually, Michael Lee Chin was anything but aggressive. Buy, Hold & Prosper was his motto.

    Having said that, I just don’t like to be at the mercy of a manager. And yes, I prefer to have faith in the market. Weird, I know, but the market is many factors, the mutual funds are one factor, the manager.

  30. Ed Rempel on July 17, 2010 at 6:58 pm

    Hi JFG,

    I’m with you on having faith in the market. We think it is essential for all stock market investors, no matter what strategy you choose.

    In general, we have found that investors that have faith in the market tend to do well, and those that are fearful do not.

    It can be difficult to have faith in the market in big bear markets, like 2008, but the market has always bounced back. People forget that it is made up of a bunch of big, solid companies, that generally can adjust their operations to increase their profits, which is why the stock market goes up long term.

    Perhaps it is a result of experience, but we have found it easier to be confident in a human being, like a fund manager. Once we have done our research and are confident in a fund manager and his methods, experience integrity, track record, etc., we get a more confident feeling from confidence in the fund manager than an impersonal market.

    Many investors seem to have almost all their information from impersonal sources, like the internet, without seeing the importance of knowing the people behind it. We have avoided some major catastrophes by not investing with fund managers with exceptional track records, but where we were not comfortable with the person.

    When the market crashes, there is a major comfort level from knowing that there is a really good fund manager hard at work making sure that anything that needs to be done is being done.

    We still have faith in the market generally, but find a greater confidence from also having faith in a human being.

    By the way, Michael Lee-Chin’s fund was a financial services sector fund. It is aggressive, since it is all in one sector.


Leave a Comment

This site uses Akismet to reduce spam. Learn how your comment data is processed.