Active vs. Indexing: Excellent WSJ Article

In a column in todays WSJ,  Karen Damato points out that in 2011 80% of active stock fund managers did not beat their respective benchmarks. But, so far in 2012, 64% are beating their benchmarks. She asks are they suddenly smarter?

Not necessarily; she points out that generally they are not suddenly smarter but rather the stocks that they are investing in are in favor. She writes:

"John Cochrane, a finance professor at the University of Chicago Booth School of Business, says investors are misguided if they think fund managers add—or subtract—value based on how savvy they are at picking individual stocks.

Managers typically have a strategy that favors certain kinds of stocks, such as those with rapid earnings growth or very low prices relative to earnings or rising dividends. Stocks with a common trait tend to rise or fall in market favor together. So the performance of a fund versus a benchmark can be better viewed in terms of the various factors a manager overweights or underweights, Mr. Cochrane says."

At the end of the day investors need to ask a couple questions:

1. If I am actively managing a portfolio, am I comparing the performance to the correct benchmark?

2. Am I earning a benchmark beating return for the fees I am paying?

What most will find is that it is a better long term solution to invest with low cost index funds.

For the complete article:

http://online.wsj.com/article/SB10001424052970203824904577215381237716676.html?mod=ITP_thejournalreport_0