“As Upton Sinclair said, it’s difficult to persuade even the most intelligent people to accept the evidence if they’re financially incentivized to ignore it.”– Robin Powell, UK Journalist & Financial Educator.

The principles of Evidence-Based Investing are woven throughout Pure Portfolios. We haven’t always called it that, but the style of rational investing has slowly adopted the name “Evidence-Based Investing” (EBI) throughout the industry.

EBI’s origins parallel Evidence-Based Medicine, which incorporates broadly accepted research to optimize the decision-making thought process for the best outcome for the patient. Sticking to the medical thesis, why would a doctor or researcher recommend a different, more costly solution if the current path to wellness has been proven time and again?

We ask ourselves the same questions about investment management. Why would portfolio managers, financial advisors, and insurance agents keep stuffing mutual funds down the throats of investors when the path to wellness (low cost index funds/ETFs) has been proven time and again?

The best answers are money, greed, and ignorance.

Per the most recent SPIVA U.S. Scorecard (annual report that tracks U.S. equity mutual fund managers), over the last 15-year period ending Dec. 2016, 92.15% of U.S. large-cap, 95.4% of U.S. mid-cap, and 93.21% of U.S. small-cap managers trailed their respective benchmarks.  Think about that for a minute. Over the last 15 years, most active mutual fund managers failed miserably to meet their benchmark. We have written about the perpetual excuses and annual promise of “this year is going to be different” (links). In our view, the argument is not about the active vs. passive debate, it’s about high cost vs. low cost and tax efficiency.

Here are some other nuggets from the 2016 SPIVA Scorecard (my comments in parentheses):

• During the same 15-year period, large-cap value managers fared better than their growth counterparts.
• Across all time horizons, most managers within international equity categories underperformed their benchmarks (not just a U.S. problem).
• Funds disappear at a significant rate. Over the 15-year period, more than 58% of domestic equity funds were either merged or liquidated. Similarly, almost 52% of global/international equity funds and 49% of fixed income funds were merged or liquidated. This finding highlights the importance of addressing survivorship bias in mutual fund analysis (the “best” performing funds that survived still had awful performance!).

Empirical data strongly suggests high cost; tax inefficient mutual funds do not work.

Evidence-Based Investing is easy to understand and rooted in common sense:

• Asset allocation is the most important decision an investor will make (how much we own of each asset class i.e. U.S. Large Cap, International, High Yield bonds, etc.).
• Tax efficient portfolios boost returns.
• Low-cost investing can result in higher returns.
• Value stocks can offer higher returns (over time) compared to growth stocks.
• Fiduciary, professional advisors place client outcomes first opposed to the broker suitability standard.

This isn’t an active vs. passive debate. It’s tax efficiency and low cost vs. the greedy establishment. We believe a disciplined active approach has a place within investment management, but the cost structure and incentive systems need to place the investor first.