The Illusion of Knowledge

Twice a year, Standard & Poor's releases a “SPIVA Scorecard” -- a report comparing the performance of active managers versus three passive indexes. The S&P 500 large caps, S&PMidCap 400 and S&PSmallCap 600 are pitted against the median returns of active managers. The results have been consistent over the years but are remarkable, none-the-less. Active portfolio management consistently fails to do as well as passive index investing. This was true for 12 month, 36 month and 60 month periods.

It gets worse: Success can not be maintained. Only 7% of investment firms who earn in the top 5 percent of companies with similar investment aims repeat in the top 5 percent the following year. The same is true for three year periods.

Actively managed (and more expensive) funds underperform the benchmark performance for their group and, when outperforming them, can not maintain their success. What this means is that unpredictability in the market trumps analysis, even seemingly quality analysis. Investment returns in one firm or another are not reproducible. They are virtually random. Active, good-idea managers can not meet the performance of passive indexing. They are only an expense.

This should be remembered when anyone comes to the point of investing in the market with the illusion of assistance. Or without assistance.
The same caution might well be applied to any modeling.