Episode summary
Stock Pickers Keep Losing, Who's Winning?
Summary
The host argues that stock pickers are underperforming by wider margins not just because investing is hard, but because the structure of markets has changed. He revisits Michael Mauboussin’s paradox of skill: as managers become more capable, it becomes harder to stand out, so luck matters more. At the same time, the rise of index funds is creating a powerful flow effect that hurts active managers and helps the largest stocks.
He cites research showing that active stock funds underperformed the S&P 500 by about 1.8% on average from 2010 to 2024, far worse than in earlier decades, even though managers’ active share has not fallen much. The host says the key difference is fund flows: when money leaves active funds, managers must sell holdings, sometimes including good ideas, while index funds buy without regard to price and push more money into the biggest names.
The host is skeptical that active management will suddenly regain its edge. He also dismisses the idea that retiring baby boomers will unwind the market in a way that restores stock-picking opportunities. For investors, his practical answer is not to abandon index investing, but to avoid concentrating in an expensive S&P 500 and instead tilt toward cheaper areas such as small caps while staying broadly diversified.
Key takeaways
- The host says active managers are underperforming more than ever, with average stock-fund lag widening to about 1.8% from 2010 to 2024.
- Michael Mauboussin’s paradox of skill helps explain why more capable managers can still do worse: as skill rises, luck matters more.
- The host says index-fund inflows force active managers to sell, while index funds mechanically buy the biggest stocks and lift their prices.
- The host argues that companies are major beneficiaries of index-fund demand because new issuance supplies much of the stock being bought.
- The host does not expect retiring baby boomers to trigger a durable revival in active management.
- His portfolio solution is to stay in index funds and ETFs, but underweight expensive U.S. large caps and overweight cheaper areas like small caps.
Notable quotes
“Active managers are getting worse. Their the level of ability to well, their level of underperformance is as bad as it's ever been”
“As you get more skill, outcomes depend more on luck because you can't get any type of edge”
“And so we can still invest in index funds and ETFs, but it doesn't have to be the S&P 500”
How the episode opens
Why do stock pickers keep losing to index funds and who's winning instead? That's what we're looking at today in episode 567 of Money for the Rest of Us, a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. Back in December 2020, at the end of the pandemic, with pandemic still going on, I invested some money in two classic active value managers.
One was Tweety Brown, the other was Southeastern Asset Management. Longleaf Partners was their small cap fund. And I've invested with active managers all my life when or at least all my professional life.
It was a big part of being an institutional asset manager as we worked with university endowments and others. We yeah, we would index the S&P 500, but beyond that, we used active managers with the idea that we were good enough to select those that were skilled versus lucky. So, I invested in Tweety Brown Longleaf Partners.
They did terrible. They underperformed and and I have since sold them from my portfolio. Tweety Brown a couple years ago, Longleaf Partners just just a month or so ago.
So, something's going on when it comes to to active management. It it's challenging to outperform and we know that. But here's what you might not know.
Active managers are getting worse. Their the level of ability to well, their level of underperformance is as bad as it's ever been. And we're going to look at why in this episode and and will it reverse?
Will they eventually be able to start adding excess return? And if so, what will need to take place for that to happen? Now, someone in the investment business I've admired for a long time is Michael Moeson.
From the episode’s captions: roughly the first two minutes, lightly cleaned. Keep watching on YouTube →
Topics
- active vs passive
- index fund flows
- stock picking underperformance
- market structure
- portfolio positioning
Watch the episode
Watch “Stock Pickers Keep Losing, Who's Winning?” on YouTube
Summary, takeaways and quote selection by Octagon. Quotes are short excerpts; the full conversation is in the episode.
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Money For The Rest Of Us, this episode and its artwork belong to J. David Stein. Octagon is not affiliated with the show; this page is an independent summary.
