One imagines the last days of the professional money managers: they retreat to their 24 room log cabins in Jackson Hole. They circle their Hummers. They break out the last of the Dom Perignon, the Beluga, and the Havanas…
Such bizarre images came to mind as I contemplated the most recent assault on professional money management: cartoons. It is true that professional money management has managed to survive years of dry academic studies and cold statistics.
It is also true that it has survived the random walk of Burton Malkiel and the unrelenting facticity of Rex Sinquefield. It has even survived all the jibes of Vanguards’ John Bogle.
But the latest slings and arrows came from syndicated cartoonist Garry Trudeau. Published in the last week of October, the Doonesbury cartoons show an elderly woman being told she has inherited about $2 million and being advised that she needs a money manager. (If you are an Internet user, you can see the cartoon series by going to: www.uclick.com.)
“No! No money managers! I don’t need one!” the elderly woman says.
“Well, let me explain what a manager does, Alice…” the attorney patronizes.
“Forget it! I just want an S&P Index Fund and some mixed T-bills.”
Later, the elderly woman explains that the market beat 87 percent of all managed portfolios over the last ten years and that’s a lot better than trying to find one of the 13 percent who will do better.
In fact, the situation for professional managers is a bit worse than that.
Measured against a universe of 882 funds that invest in large capitalization stocks, the Vanguard Index 500 fund was in the top 13, 6, 6, 10, and 8 percent over the preceding 12 month, 3 year, 5 year, 10 year, and 15 year periods. So Mr. Trudeau wasn’t exaggerating. Most of a growing number of S&P index funds available from other vendors offered similar performance. In other words, in most time periods, the index beat 9 out of 10 managed portfolios.
Worse, the actual performance gap was gigantic. Below, for instance, are the figures for the Vanguard Index 500 fund, the 882 Large Blend funds that can be considered direct competitors, and the 3373 funds that invest in domestic equities.
Behind So Long, Behind So Far: Managers Trail the Index
| Measure | 1 year | 3 years | 5 years | 10 years | 15 years |
| Vanguard Index 500 Fund | 8.96% | 22.50% | 19.79% | 17.10% | 16.15% |
| Avg. Large Blend Fund | 2.80 | 17.78 | 15.90 | 14.60 | 13.30 |
| Avg. Domestic Equity Fund | -6.56 | 13.23 | 13.36 | 13.81 | 12.51 |
| Vanguard Balanced Index Fund | 6.96 | 15.11 | 13.26 | NA | NA |
Source: Morningstar Principia Pro, 9/31/98 data
As you can see, even the large blend funds that draw from the same pool of stocks trail consistently and miserably. Widen the types of funds considered to any domestic equity fund and the gap is even larger. Indeed, the gap is so large that Vanguard Balanced Index, a fund that invests 60 percent in equities and 40 percent in bonds, appears to offer strong competition to the average domestic equity fund. Similarly, in a recent exercise, I found that a two-thirds stock index, one-third bonds 401k contribution beat all but one of the equity funds most frequently used in 401k plans.
Now take a look at the percentile rankings for three major Vanguard Index Funds. As you can see, they are consistently among the top funds, often in the top 20 percent.
Indexing Looks like a Consistent Winner
| Fund | 1 year | 3 years | 5 years | 10 years | 15 years |
| Vanguard Index 500 | 13 | 6 | 6 | 10 | 8 |
| Vanguard Total Bond Index | 22 | 15 | 17 | 29 | NA |
| Vanguard Balanced Index | 19 | 17 | 16 | NA | NA |
Source: Morningstar Principia Pro, September 31, 1998 data
This is not an advertisement for Vanguard funds. After years of being alone in the field, they now have competitors. There are 226 index funds: including 149 domestic equity index funds; 3 government bond index funds; and 23 corporate bond index funds. (The remaining index funds invest overseas.)
Indexing first began in 1973 as a response to studies showing that professional pension fund managers failed to beat the index 70 percent of the time. The basic notion was the professional selection could not overcome even the modest costs involved in pension fund management. Since then I have heard managers carp and complain about indexing while salesmen with a flair for the dramatic ask why you would be willing to accept the mediocrity of an index.
Now, with a cartoonist poking fun, the shoe is on the other foot. The first question a professional manager needs to answer isn’t how he or she picks stocks but how he or she justifies the risk of taking a one in five or one in ten shot at doing better than an index fund. Some can give a good answer to that question… but the majority can’t.
Photo: Kampus Production
(c) A. M. Universal, 1998