What Can the S&P 500 Index Teach Active Managers?

Abstract

Implicit in active fund management is the presumption that the S&P capitalization indices (i.e., S&P 500, S&P 400, and S&P 600) can be bested. Needless to say, active fund management on the whole has not lived up to expectations, with portfolios regularly trailing their respective indices. Thus, the claim by active managers in aggregate that they can beat an index is naïve and statistically impossible. However, the performance disparity between active and index funds shows that there is a lot of room for improvement. That most managers are unable to beat their respective indices is not indicative of the quality of the selection criteria used to build these benchmarks. Rather, it is indicative of the inherent deficits of active investment management practices. The objective of this article is to highlight some of these flawed practices and, in the process, suggest ways to improve the state of the art.