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By Charles Rotblut

Index funds are better than the majority of their actively managed peers, according to Standard & Poor's. In the 10th annual SPIVA (S&P Indices Versus Active Funds) Scorecard, S&P bluntly stated,

"The only consistent data point we have observed over a five-year horizon is that a majority of active equity and bond managers in most categories lag comparable benchmark indices."

The numbers favor index funds across market capitalizations, styles and geography. Index funds also hold their advantage across asset classes-returns are better for stock, bond and real estate index funds. Though there are actively managed funds that bested their category benchmarks, the majority failed to do so.

Since numbers can often speak better than words, here is the percentage of funds that were outperformed by their benchmarks over the past five years:

  • Domestic Large-Cap Stock Funds: 61.93%
  • Domestic Small-Cap Funds: 72.56%
  • Domestic Real Estate Funds: 70.24%
  • International Stock Funds: 77.98%
  • Emerging Market Funds: 82.89%
  • Government Long-Term Bond Funds: 93.62%
  • Investment Grade Long-Term Bond Funds: 96.77%
  • High Yield Funds: 96.06%
  • General Municipal Debt Funds: 90.24%

Was there any category where active managers, in aggregate, performed better? Only two: large-cap value and international small-cap.

During the past five years, only 36.71% of large-cap value funds underperformed their benchmarks. However, 54% of large-cap value funds lagged their benchmark over the past one-year and three-year periods. Hence the advantage of active management is questionable at the aggregate level.

International small-cap is an area where you may to consider favoring active management. Only 26.09% of actively managed international small-cap funds lagged their benchmark over past five years, and the one-year number is not considerably higher at 38.18%.

These numbers suggest that active managers, as a group, need inefficient markets to excel. Though domestic micro-cap was not broken out as a separate category, this may be one other area that would favor an active, instead of an index, approach.

The numbers also suggest that individual investors may do best by using large-cap and broad-market index funds-including ETFs such as the SPDR S&P 500 (NYSEARCA:SPY), Vanguard Large-Cap ETF (NYSEARCA:VV) or the Dow Jones U.S. Index Fund (NYSEARCA:IYY) -- and supplementing their portfolios by including value stocks with smaller market capitalizations and lower average daily trading volumes. (Our Model Shadow Stock Portfolio follows a micro-cap, value-oriented strategy.)

It should be noted that some active managers are beating their benchmarks, so astute selection of mutual funds may produce benefits. Pay attention to the investment styles, since more than half of domestic stock funds incur style drift. This is not a problem if you want a "go anywhere" manager, but it can cause headaches if you are buying a fund to fill a specific allocation need in your portfolio. (Real estate, international equity, and bond funds have higher style consistency rates.)

Source: Indexing (Mostly) Beats Active Management