Why do stock funds perform so poorly? How bad is it?

For stock funds, I suggest that friends can refer to my previous highly relevant article: “Any strong reason to buy mutual fund?“

Table of Contents

How are equity funds performing?

In Section 4-3 of the book “The Rules of 10 Baggers“, pages 143-154, I mentioned the following in the discussion article on “Reason 2” of “Investment Strategy” “Active investment should be over-dispersed, it is better to invest directly in the market” content.

Long-term investigations by several well-known financial institutions:

Consistent long-term research by many institutions, including Bank of America (ticker: BAC), indicates that only 25% of equity fund managers outperform the broader market.
According to the statistics of Morningstar Direct under Morningstar (ticker: MORN) in 2021, the performance of active US stock funds lagged the market by more than 85%.
The latest report from S&P Dow Jones Indices (ticker: SPGI) shows that more than 79% of active mutual fund managers will perform worse than the S&P 500 and Dow in 2021.
The S&P Indices Versus Active (SPIVA) scorecard, which tracks the performance of active funds, with year 2023’s data showing that 79% of fund managers will underperform U.S. stocks in 2022, up from 42% a decade ago.

John Bogle has done a lot of research himself, and also cited research from a large number of authoritative institutions and people. For example, he cited research by David Swensen, chief investment officer of the Yale University Foundation: Among the many funds like ants, only about 4% of them have outperformed after taxes and fees over the past two decades. The return rate of the market is only 0.6% higher than that of the market on average; 96% of funds underperform the market, and they lose miserably: they underperform by an average of 4.8% per year. Everyone knows that fund managers and brokerage firms have made fortunes, but few have heard of fund investors who have made fortunes.

Very hard for funds to beat the market in the long run

Over the past few decades, among thousands of funds, only Mr. Bill Miller’s fund from Legg Mason has outperformed the S&P 500 Index for fifteen consecutive years. However, the margin of outperformance was not large. Later, his fame became bigger and the new money of the fund increased, but it became more and more difficult for him to outperform. In the recent years, he has seriously underperformed the market. After all, he even retired altogether later. The very fact that Mr. Miller has become a great hero for beating the market shows that beating the market is as difficult as winning the lottery.

Typical case Ark Innovation ETF

History and fund size

Founded in 2014, Cathie Wood’s flagship fund, the Ark Innovation ETF (ticker: ARKK ), has total assets under management of $13 billion.

An impressive short-term performance

Please pay special attention to the word “short-term”. Short-term performance will not be sustainable, and it is impossible to accumulate satisfactory wealth in the stock market. For details, please refer to my previous blog post g “A investor can be sustained or not? how to verify?“.

ARKK has performed well during the new crown pandemic, and its portfolio stocks have risen sharply during the epidemic. ARKK plummeted from extremely high levels as the tech sector entered a downturn as the coronavirus pandemic receded and the Federal Reserve aggressively raised interest rates. From a peak of $159.70 in mid-February 2021 to an intraday low of $29.43 on December 28, 2022, the fund’s peak-to-trough decline was 81.6%.

Since the fund’s inception, ARKK investors have had a dollar-weighted return of about negative 27%, according to FactSet.

High management fees

About 70% of the $310 million in commission income since the fund’s inception was collected after February 2021. ARKK has an annual management fee of 0.75%, double the average for actively managed ETFs, according to FactSet. Since the establishment of the fund, it has earned US$310 million in commissions, and investors have lost US$9.5 billion.

Blame the investors themselves

The price of Cathy Wood’s flagship fund ARKK has plummeted, but many fans are still full of confidence in it, just because she “used” to create impressive performance. But the problem is that it is long-term performance, not short-term performance, that determines the success of stock market investment! To paraphrase the stock market language in the Chinese world, many fans are still willing to become leeks, and have not yet awakened.

The absurdity and ignorance of Taiwanese media

In particular, Taiwan’s media was the first in the world to call Cathy Wood the “Female God of Stocks” and hailed her as the successor of Warren Buffett. Regardless of the long-term return on investment, the scale of assets under management, stock market experience, investment experience, and understanding of the capital market, Cathy Wood and Buffett are not investors of the same magnitude at all, and the gap between them is very far . Comparing the two together is like comparing apples to oranges, or comparing elementary school students to doctoral students. The level of absurdity and ignorance is beyond words.

Note: As far as I know, the English media usually refer to Buffett as the “Oracle of Omaha”. I have never read any English articles where anyone calls Buffett the “God of Stock”. In short, Taiwanese media are used to deification of their favorite subjects of reporting, such as calling TSMC (ticker: TSM) the sacred mountain of protecting the country of Taiwan. This kind of practice violates the fundamental taboo of journalists, and also mixes personal opinions, which is very undesirable and extremely unprofessional.

In contrast, mainland China, which now is more popular in the Chinese-speaking world, is more conservative. It did not follow Taiwan to make a fuss, and only called her “Sister Wood”, which is a direct translation of her English into Chinese.

Note: Note: It is very common in mainland China to directly translate the name of the protagonist who first appeared in the media in foreign media into Chinese, or a similar joke in Chinese; for example, Meta (ticker: Mark Zuckerberg, the founder of META, is called Xiao-Zha (meaning little-Zuck) , and Sundar Pichai, the CEO of Alphabet (ticker: GOOGL and GOOG), is called Pi-Chai Ge (meaning Brother Chopping-Wood) because the similar pronunciation in Chinese. It is rare to deify the protagonist of news reports.

Buffett’s view

In his 1965 letter to shareholders, Buffett listed five reasons why stock fund managers underperform. The following is my complete excerpt:

In the great majority of cases the lack of performance exceeding or even matching an unmanaged index in no way reflects lack of either intellectual capacity or integrity. I think it is much more the product of:

(1) group decisions – my perhaps jaundiced view is that it is close to impossible for outstanding investment management to come from a group of any size with all parties really participating in decisions;
(2) a desire to conform to the policies and (to an extent) the portfolios of other large well-regarded organizations;
(3) an institutional framework whereby average is “safe” and the personal rewards for independent action are in no way commensurate with the general risk attached to such action;
(4) an adherence to certain diversification practices which are irrational; and finally and importantly,
(5) inertia.

Conclusion

Facts speak louder than words. 79% to 85% of US stock fund performance will lag behind the stock market in the long-term. Therefore, the best choice for investors who cannot choose their own stocks is a large-cap ETF.

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