It came to light today that the Rhode Island Pension Fund lost 19 percent of its value over the last 12 months...outperforming the major indices and most major pension funds. Rhode Island's General Treasurer Frank Caprio has gone to great lengths to lessen the investment management costs of state's pension funds including using index funds for the fund's equity exposure. In fact, in a recent article he claimed that the move to indexing saved the fund upwards of $9 million in fees.
A recent study by Eugene Fama and Kenneth French once again points to the fact that fewer than 1% (0.6%) of fund managers actually add value above their most appropriate benchmark. Even more depressing is the fact that as years go by, fewer and fewer equity managers actually bring any alpha to the table at all.
The key of course is "appropriate benchmark." We see many active managers benchmarking themselves to the S&P500 and then showing alpha of 1% plus. A little digging shows that the stocks they are buying are considerably smaller in capitalization than the S&P500, and that when capitalization and risk are taken into account...the manager is actually underperforming a similar index.
The key? Unless you can find the 0.6% (and falling) of active managers who truly bring alpha, just buy the index.