Active Funds Fail Again & Again
The evidence is overwhelming that most actively managed funds underperform their appropriate benchmarks, especially after taxes.
However, not all actively managed funds underperform, just a large majority of them. Those who believe in active management as the winning strategy believe they can identify the small minority of actively managed funds that will outperform. The only-somewhat logical way to choose these funds is to rely on past performance as a predictor of future returns.
One test of whether or not past performance is predictive of future performance is to see if more actively managed funds outperform than would be randomly expected. If fewer funds do so, it’s hard to know if any outperformance was simply a result of random luck—just as someone might flip 10 heads in a row—or skill. Because there are enough actively managed funds in the market playing the game, at least some should be randomly expected to outperform their benchmark 10 years in a row.
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