In this summary paper, Dimensional Fund Advisors's James Davis reviews the academic research on equity mutual-fund performance from 1969 to 2001. With some minor exceptions, the research shows the following:
- The vast majority of actively managed funds lag passive benchmarks.
- Some fund managers do have above-average stock-picking skill, but usually not enough to allow them to overcome the costs of their own trading and compensation.
- Almost all fund performance can be explained by four "factors": the market's performance, the relative size of the stocks in the portfolio, the relative valuation of stocks in the portfolio, the relative "momentum" of stocks in the portfolio. These factors have little to do with traditional "stock-picking."
- The market is not perfectly efficient, but its inefficiencies are not large or regular enough to exploit consistently.
In short, the vast majority of mutual funds lag the market. They do this not because their managers are stupid but because beating the market is hard. Fund buyers who want to give themselves the best chance of success should therefore choose among low-cost passive funds.
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