Mutual Funds: To Index or Not to Index

Abstract

The controversy whether mutual fund shareholders should invest primarily in actively managed funds index funds continues. But, while there may be a small number of portfolio managers who provide evidence of persistency in high performance (assuming they meet the daunting statistical burden of proof), in most cases such performance is likely due to chance. Based on the hype for "star" portfolio managers, it is easy to forget that it is very difficult indeed to produce statistically significant superior performance.

Further, as reported by Jonathan Clements (2000), Professors Rubinstein and Sharpe both succinctly make the current case for index funds. Rubinstein believes investors spend too much time on research and trade too few stocks too often, which has the effect of making the market more efficient. He concludes that "...it's not cost effective to keep mining." In turn, Nobel Laureate Sharpe accepts the "compelling" argument that the market is not entirely efficient in the rational investor sense. Nonetheless, he still concludes that investors on both sides of the argument " ...should behave as if markets are efficient."

Keywords: actively managed mutual funds, index funds, rational investor, market efficiency, star portfolio managers