Are there funds that have performed better than those that follow the total stock market?
I keep hearing about passive and indexed funds and how they have performed. Are there any other funds out there, not following the whole market, that have performed better than funds that follow the total stock market? For example, like in the the past 5 or 10 years?
The major difference between an active managed fund and a passive fund is the word “active”, in which the manager actually seeks a different investment strategy, instead of simply following a preset index. You used the phrase, “total market”, in the question, which means any passive index fund that follows the total market index essentially uses all companies in the market. You may begin to wonder how one fund family’s “total market” differentiates from another fund family’s “total market’ if they all follow the same index. You’re correct: they are almost no difference, except one family could charge less fees than the other, which may translate to a higher return to you.
What a boring investment would be if everyone follows the same index! That’s why there’s a breed of active asset management. Managers seek to follow a different path and prefer zig when everyone else zags. Instead of doing a “total market”, the managers may select only the small capital companies or international markets to invest. With this type of activing picking/managing, life gets exciting, but it fraught with risks, rewards, high turnovers of the underlying investments, and also the corresponding increased fees.
As you can see, there’s no right or wrong answer to choose what the right style for you. Even though studies show index funds beat the active funds in many categories, but in certain areas, such as international and emerging markets, active management seems to be the leaders. You can pick one or the other, or mingle them up to have the best of both worlds. Isn’t investment fun? Best!
In any given years, there are always some funds that perform better than the index. Are they just lucky or the managers truly have skills to beat the market? Study after study have showed that it is mostly due to luck. Since there are so many funds in the world, there bound to be some that will beat that market.
A good analogy would be a stadium full of people tossing coins. After the first coin toss, heads remain standing, tails sit down. About half will remain standing. After the second coin toss, head remain standing, tails sit down. About a quarter will remain standing. So on and so forth. After the tenth coin toss, odds have it that there are five people remain standing. They have consecutively tossed head ten times. Are they expert coin tossers? They are not. If you try another round of ten coin tosses, they could sit down very quickly.
The same logic applies to outperforming funds.
Your question is two-pronged. One is investment style. The other is return performance.
Regarding investment style, if you want funds that do not follow the market, you want something that has low correlation to the market. You look for a fund that has a low BETA, or a low correlation index to the market. Typically, bond funds have a low correlation to the market. However, their returns are also lower. Within the bond funds, there are higher return sectors too. They are typically lower credit, higher duration (or combination) or international bonds. All this increases the volatility and also correlation with the stock market. The other investment style is called Alternative Investments which is everything else. They could trade on potential mergers and acquisitions, global macro trends, complicated put call strategies to yield an absolute target return. These funds have low correlation with the market.
Your next question is on return performance. There will always be funds that meet your 5 or 10 year performance criteria. All you need to do is get a software and screen for the funds. After getting your short list of superior fund performance, you want to know how much risk you are taking in to generate the return. Nothing is free, right? Check for downside capture, standard deviation, sortino ratio, absolute drawdown etc. I would also recommend reading the investment strategy synopsis to identify possibility of 3 standard deviation blowups. The trading strategy could work very well under normal market condition but could blow up big time when certain investment environment hits.
Be careful. I would recommend sticking with what you know and what you are comfortable in investing.
Yes there are funds that have beaten the Total Stock market Index over time. But you need to accept that they will have down years and be out of favor from time to time. Bill Miller at Legg Mason beat the S&P 500 for 15 years before the credit crisis. Vanguard Total Stock market ha returned 9.97% over the past 15 years, 7.26% ovet the past 10 years, 14.88 over the past 5 years, 9.55% over 3 years. YTD it is up 11.23%.
For example Alger Capital Appreciation has outperformed Total Market 1,3,5,10 and 15 years. Over the past 15 years it has returned 11.82%, 9.27 over the past 10 years, 16.06 over 5 years, 10.94 over 3 years, 20.83 over 1 year and is up 21.51 YTD through 7/20/2017. But when you look at each year by itself you see some significant outperformance and some significant underperformance. In 2007 Total Market returned 5.49% while Alger returned 31.63%. In 2008 Total Market was down 37.04% while Alger was down 43.89%. In 2009 Total Market was up 28.7% while Alger was up 49.12%. in 2010 Total market was up 17.09 while Alger was up only 13.48%. In 2015 Total Market was up 0.29% while Alger wasup 6.23%. In 2016 Alger was up 0.46^ while Total MArket was up 12.53% and YTD Alger is up 16.47% while Total Market is up 8.94%.
Any fund that outperforms the Total Market will be more risky in term of sector weightings and concentrated bets. They will also be more expensive. To outperform the Total MArket the manager needs to deviate significantly from the benchmark and have be right nearly all the time. You are paying fro their stock picking ability not to mimick an index like Total Market.
Funds that outpeform should only be held in retirement accounts as turnover is generally high so capital gains will be an issue.
In general it is difficult to beat the Total Market consistently over 5,10& 15 years. Managers can do it over 1 & 3 years but it gets harder and harder. After 5 years over 85% of active managers do not beat their benchmark.
Since the total stock market is made up of many different funds and many different stocks, unless they all performed exactly the same as the market average there will always be some that outperform. The outperformance, however, will usually be for periods of a few years or less, very rarely on a ongoing basis. Two exceptions I can think of are PRIMECAP Odyssey Aggressive Growth Fund and Parnassus Endeavor Investor. Both have topped the S&P 500 over the last 10 years by wide margins. Even so, past performance is no guarantee of future results, so even these two standouts may not continue their winning ways.