Follow the Money
Following the money, in the investment management world, means keeping track of which types of investment strategies are in favor, and which are losing popularity.
Following the money shows that investing strategies that simply track the markets, rather than look to outperform them, have dramatically transformed the capital markets. (We like to refer to market tracking funds as "haystack" funds as they own substantially all of the securities in a given area of the markets - the whole haystack, as opposed to trying to find the needles...)
Today, the largest (in terms of assets) mutual fund and exchange traded fund, the Vanguard Total Stock Market Index, and SPDR S&P 500, respectively, simply track the returns of well-known U.S. stock indexes.
According to the Wall Street Journal, funds that track broad U.S. stock market indexes now have more money invested in them than their stock-picking actively-managed rivals. In the last ten years ended August 2019, nearly $1.4 trillion of net cash flows were added to U.S. funds (both mutual funds and ETFs) that track market indexes, while about $1.3 trillion was withdrawn from actively managed funds.1
It’s not hard to understand why indexing has become so popular. During the 2008 financial crisis, investors realized that active funds didn’t protect them from the downturn. And during the lengthy bull market that followed, active managers’ performance didn’t keep pace with index funds.
While it's too early to tell whether "haystack" funds or "needle" funds will have performed better when we look back at the Covid-19 crisis, over the long run, I would not bet against market tracking funds as the most effective approach to wealth management.
Looking back at the 15 years ending December 2018, only 18% of active stock mutual fund managers beat their benchmarks. For bonds, the failure rate was even worse, with only 15% winning.2 You better be awfully confident in your choice of active fund managers if more than 4 out of 5 fail at their mission. Want the odds in you favor? Own the haystack.
In US dollars. The sample includes funds at the beginning of the 15-year periods ending December 31, 2018. Winners are funds that survived and outperformed their respective Morningstar category benchmark over the period. US-domiciled open-end mutual fund data is from Morningstar and Center for Research in Security Prices (CRSP) from the University of Chicago. Past performance is no guarantee of future results
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