Wednesday, November 08, 2006

Worse than a Coin Flip

I was recently reading about the possible end of Bill Miller's win streak against the S&P500 Index. His Legg Mason Value Fund has beaten the S&P500 for an impressive 15 years in a row. However, this year he's trailing the index by about 10% at this point. The manager with the next longest streak is Manu Daftary, who's Quaker Strategic Growth Fund has beaten the index for eight years in a row. However, he's also trailing the S&P500 by almost 9% this year. After him, there's a handful of funds with a seven year streak.

It got me wondering how many funds you would expect to beat the S&P500 if the results were represented entirely by chance: flip a coin, heads you beat the market that year, tails you lose. There are approximately 8,600 mutual funds out there, so if the results was entirely by chance, half (4,300) would beat the market after one year. If half of those beat the market the next year, then 2,150 would have beaten the market for two years and so on. After eight years, there would be 67 who beat the market for eight years in a row. Instead, in real life there are only two, Miller and Daftary.

True, beating the S&P500 each year isn't the only goal of all mutual fund managers, but it's still interesting nonetheless to note that only two out of thousands of mutual funds--with managers paid millions of dollars a year to beat the market--have managed to beat the market for even eight years in a row. A coin flip would have done much better.

1 comment:

Pete said...

I like your analysis. I did a similar article a month ago or so about why invest in a low cost mutual fund (or ETF).

Yet, to be fair, about 1/4 to 1/2 of all mutual funds are indexed funds that will not beat their average (e.g., S&P 500) just match it. Thus, instead of expecting 67 to beat the S&P 500 after 7 years (note 8,600 X .5 ^ 7 = 67) it would be around 35. Yet, still a valid point.