Index funds beat active management.
Active portfolio management does not add value while index funds offer a better option according to Vanguard group director and Princeton University Professor of Economics Burton Malkiel.
Malkiel says the chief reasons for active managers not adding appropriate value is that costs and market timing hamper their performance.
"Markets are efficient and react well to news and given that it is difficult to respond before anyone else to get a better position," Malkiel says.
"At the same time active managers turn over a portfolio regularly which incurs costs and investors, particularly institutional investors, don't always see that."
He says management costs between the two styles of funds are also at odds with an index fund averaging around 10 basis points while an active fund averages around 150 basis points.
At the same time Malkiel says it is difficult to beat the market as they themselves make up the market. He points out that the Vanguard 500 Trust Fund, the largest managed fund in the US has outperformed over three quarter of active managers in the last ten years and over 80 per cent in the last five years.
"Investors may ask about the performance of active managers in the remaining percentages in both of those periods but the question should be how will people know who they are before they invest funds," Malkiel says.
The threat of being caught in a stock bubble and suffering when the market turns is a concern. However Malkiel says the best way to avoid this is to diversify into other sectors and take an index approach there also.
"At present technology stocks are nearly one third of the US market and some see this as a bubble while others as part of a new industrial revolution. Valuations may prove true over time but for some stocks this may be a bubble," Malkiel says.
"The paradox is that the index has yet to beat active managers and while the index is heavy is technology stocks, those managers are even more so, with the attendant results that come with a bubble bursting."
AUTHOR
Jason Spits
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