Wall Street Is a Rentier Rip-Off: Index Funds Beat 99.6% of Managers Over Ten Years

The entire financial management industry is a profit-skimming rentier arrangement.

It may seem uncharitable to note that only .4%--that's 4/10th of 1%--of mutual fund managers outperform a plain-vanilla S&P 500 index fund over 10 years, but that is being generous: by other measures, it's an infinitesimal 1/10th of 1%.

Most Hedge Funds Underperforming The S&P 500 For Fifth Year In A Row - Full YTD Performance (Zero Hedge)

Beginner's Strategy: Investing in Low-Cost Index Funds

According to the folks at the Motley Fool, only ten of the ten thousand actively managed mutual funds available managed to beat the S&P 500 consistently over the course of the past ten years.Consider the following: a quick glance at Yahoo Finance reveals the average expense ratio for growth and income style mutual funds is 1.29%. As a result, approximately $1,883 of every $10,000 invested over the course of ten years will go to the fund company in the form of expenses. Compare that to the Vanguard 500 fund, designed to mirror the S&P 500 index, which boasts an annual expense ratio of only 0.12%, resulting in ten-year compounded expense of $154 for every $10,000 invested.

Frequent contributor B.C. recently screened 24,711 funds on Yahoo Finance's fund screener and 17,785 funds on the Wall Street Journal's online screening tool. The results were sobering, to say the least: using a basic set of criteria, the first screen turned up a mere 5 managers who beat the S&P 500 index over five years. Using a slightly different set of criteria, the second screen found 71 funds out of 17,785 outperformed the index over ten years.

That's .4% of managed funds, i.e. an index fund beat 99.6% of all fund managers.

So what do we get for investing our capital in mutual funds and hedge funds? The warm and fuzzy feeling that we've contributed the liquidity needed to grease a monumental skimming operation. Ten out of 10,000 is simply signal noise; in effect, nobody beats an index fund.

The entire financial management industry is a rentier arrangement: they skim immense profits and return no productive yield at all. This is of course a key characteristic of the neofeudal debtocracy that is the U.S. economy: various cartels and state fiefdoms operate rentier arrangements that skim a percentage of the national income, protected by the state and endless PR from any market forces or transparency.

B.C.'s analysis and commentary:

Here are the most recent results for the quarter ending Q1 '13 for mutual fund managers' performance vs. the total return to the S&P 500using the Mutual Fund Screener from Yahoo Finance (data from Morningstar):

First Screen Criteria:
All funds.
Manager tenure 5 years or more.
No load.
Management fee of less than 1%.
YTD: >5%
1-yr.: >10%
3-yr.: >5%
5-yr.: >0%
Number of managers who beat the S&P 500 over the past five years: 0

Second Screen Criteria:
All funds.
Manager tenure 5 years or more.
Load less than 2%.
Management fee less than 2%.
YTD: >5%
1-yr.: >10%
3-yr.: >5%
5-yr.: >0%

Number of managers who beat the S&P 500 over the past five years: 5

The screener includes a universe of 24,711 funds, which means that those who "beat the market" were in the fifth-order Pareto distribution of 2-3 out of 10,000.

Using similar criteria for the WSJ.com Mutual Fund Screener without the option of choosing manager tenure but including Lipper relative performance to peers, load-adjusted performance, and with an A-AAA rating, only 71 funds (fewer managers because of multiple fund management by a manager) of 17,785 matched or beat the S&P 500 over 10 years.

Once again, evidence of a third- or fourth-order Pareto distribution of 2-4 out of 1,000 being "winners."

The results of the past 10-12 years during the ongoing secular bear market clearly demonstrate that the "money management" industry exists primarily, if not now exclusively, for the benefit of those who "manage" other people's money, not the investors/shareholders of the funds.

By definition "hedge" funds are no better, i.e., they hedge investors' returns to no better than cash:

Hedge Funds: Going nowhere fast (The Economist)

"The past year has been another mediocre one for hedge funds. The HFRX, a widely used measure of industry returns, is up by just 3%, compared with an 18% rise in the S&P 500 share index. Although it might be possible to shrug off one year’s underperformance, the hedgies’ problems run much deeper.

The S&P 500 has now outperformed its hedge-fund rival for ten straight years, with the exception of 2008 when both fell sharply. A simple-minded investment portfolio—60% of it in shares and the rest in sovereign bonds—has delivered returns of more than 90% over the past decade, compared with a meagre 17% after fees for hedge funds (see chart). As a group, the supposed sorcerers of the financial world have returned less than inflation."

B.C.'s commentary resumes:

That there are so many "managers" in the game with AUMM (assets under mis-management), all manner of ETFs, and now pension funds "discovering" index funds and index ETFs, all trying to match or "beat the market", is a primary reason why the overwhelming majority of " managers" will underperform and thus add no value to an investors' portfolio. 

Eventually, a growing plurality of so-called "investors" will discover that the stock market is not for wealth accumulation for the majority of "investors" but a wealth-transfer mechanism from the second 9-19% with any financial surplus to the top 0.1-1% who hold a disproportionately large share of financial wealth, and to the so-called money "managers" who benefit from fee income generated by the wealth-transfer process.

However, the resources of the financial services industry generated by fee income will continue to fund mass-media advertising/propaganda in the ongoing attempt to convince the top next 19% that they can "beat the market" if only they turn over their savings to the industry to "manage". Little do most "investors" know that they are funding the perpetuation of the industry's fraud, their own underperformance, and failing to match risk-adjusted returns of cash and fixed income after fees, taxes, and inflation over a cycle.

Now, imagine what would happen to the financial services and banking industries and financial print, broadcast, and online media were these unsanitized facts about dismal money "manager" performance to be widely reported and internalized by a significant minority or small plurality of investors or the public at large.

Thank you, B.C. In my analysis, the financial services industry is simply one of many state-enabled cartels and rentier arrangements that are immune to market forces, price discovery and the bright light of truth.

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Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

1. Debt and financialization
2. Crony capitalism and the elimination of accountability
3. Diminishing returns
4. Centralization
5. Technological, financial and demographic changes in our economy

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

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