Actively passive

More and more investors have over the past decade started to accept that it is very difficult indeed to outperform the market. Hence, we've seen an increase in the market share of passive funds relative to actively-managed funds.

Mark Hulbert of MarketWatch reported on the latest trends as published by Morningstar:

Morningstar calculates that, a decade ago, more than 89% of mutual fund assets in this country were invested in funds whose managers were actively engaged in beating their benchmark. By the end of 2009, in contrast, the actively-managed share had dropped to 78%.
To appreciate how big a shift this is, consider that the 22% that is passively managed now totals $1.7 trillion.

Might this marked shift towards passive management have made the market more easily beaten? That's an intriguing question, since the markets' much-vaunted efficiency comes from so many investors trying to do better than simply buying and holding. That means, ironically, that in a world in which everyone is invested in an index fund, the market would be quite easy to beat.

Don't get your hopes up, however. There is still more than enough money devoted to beating the market to keep it as efficient as ever. For example, the assets that remain invested in actively-managed funds remain huge -- some $6 trillion, according to Morningstar.

Furthermore it is worth remembering that investment managers who are trying to beat the market trade much more frequently today than they did a decade ago. So, even though active fund managers have a smaller market share than a decade ago, on average they today are more aggressive in their active management. These two trends largely cancel out, leaving little net effect on market efficiency.

How hard is it to beat the market?

My three decades of tracking investment advisers has shown that, over long periods of time, about one out of five advisers are able to do better than simply buying and holding an index fund. While that means it isn't impossible to outperform the market over the long term, the odds are stacked against us.

And, unfortunately, despite the tantalizing possibility that the last decade's trends might have lessened those odds that are against us, they most likely remain every bit as steep.