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Why Investors Are Now Giving Up

http://www.fool.com/investing/mutual-funds/2009/05/06/why-investors-are-now-giving-up.aspx

Amanda B. Kish, CFA
May 6, 2009

After the market rout of the past year and a half, countless investors are re-thinking some of their most cherished maxims: Are stocks really a good long-term vehicle for creating wealth? Is buy-and-hold dead? Should I just stuff my retirement money under my mattress?

Some discouraged investors have decided to take the path of least resistance -- they've thrown in the towel and resigned themselves to never beating the market.

Content to be average
According to data from Lipper, investors yanked over $221 billion out of actively-managed mutual funds in 2008. So, where did that money go? Well, a big chunk of it was funneled into passively-managed index funds and exchange-traded funds like Spiders (NYSE: SPY  ) and the iShares Russell 1000 Index (NYSE: IWB  ) . Index funds saw new inflows of over $17 billion last year, bumping up their share of the mutual fund market to 13.2%. Apparently, scores of investors are giving up on ever being able to outperform the market and are content to merely match its return.

And who can blame them? Many actively-managed funds have done a dismal job of keeping pace with the market during this most recent downturn, losing more ground than some benchmark indices. Some fund shops were caught flatfooted by the crisis in the financial arena and lost big on names like Citigroup (NYSE: C  ) and Fannie Mae (NYSE: FNM  ) .

Furthermore, it's absolutely true that the vast majority of active mutual funds don't beat the market. It leads one to wonder why you should pay for the advice of a fund manager if you're just going to lag the market anyway. Why not just throw your money in an index fund and be done with it?

Diamonds in the rough
While abandoning the game of trying to outperform the market may be appealing in tough times, if you do give up, you're leaving a lot of money on the table. And while they definitely have their problems, I wouldn't count actively-managed funds down for the count just yet.

It's true that most such funds simply can't beat the broader market over the long-run, but there are a select number of exceptionally skilled managers who do manage to trounce the market. The problem lies in finding these needles in a haystack of competitors. Fortunately, there are a few easily identifiable features that almost all top-notch funds have in common.

In the Winners' Circle
One of the first things to look for is funds with a long-tenured manager or management team at the helm. Numerous academic studies, such as a 2004 study in The Journal of Investing performed by Greg Filbeck and Daniel Tompkins, have proven that funds with longer-tenured managers tend to outperform funds with newer talent on board. For example, the Stratton Multi-Cap Fund (STRGX) has been run by manager James Stratton since its inception in 1972. For more than three-and-a-half decades, Stratton has invested in high-quality companies like Owens-Illinois (NYSE: OI  ) , Harris Corporation (NYSE: HRS  ) , and Schnitzer Steel Industries (Nasdaq: SCHN  ) -- and racked up a first-rate track record doing so. Over the rec