Is actively managed funds dead?

In today’s Wall Street Journal there is an article on Bill Miller legendary stock picker for Legg Mason’s Value Trust Fund (Article:Stock Picker's Defeat). According to the article the fund outperformed the Standard & Poor’s 500 Index from 1991 to 2005. Now due to recent losses and big bets on financial stocks the fund has underperformed the S&P 500 for nearly all time periods. So does this mean investors should abandon stock pickers and just invest in index funds?

There are plenty of people who would say yes, but I say not so fast. Index funds are great and should be part of your overall stock portfolio, but that does not mean you should not even consider actively managed funds. It is true that over long periods of time index fund outperform most actively managed funds. I attribute part of that to the fact that there are so many bad actively managed funds. Let me explain what I mean by bad without naming any funds. A bad actively managed fund would be one with high expense ratios and 12b one fees. The higher the fees the less likely the fund manager will be able to outperform the market. You also need to consider were the fund is spending its fees. If it is going to wholesalers and brokers to push the fund, then investors are getting no return on investment for the fee. If the fees are going to pay for research and analyst than that should provide value for fund investors in the form of higher returns. Another thing you want to be careful of is so called actively managed funds that are really index funds. This is where a fund claims to be actively managed and charges a higher fee than an index fund but invests like an index fund.

Proponents of index funds would say why bother with all that and just relax and invest in a low cost index fund. I say if you are willing to do a little research and find some low cost actively managed fund with a fund manager that has a solid track record; it can pay off big time. Just a 1% higher return can be thousands of dollars over a 10 to 15 period. Of course I realize that it works the other way to.

The bottom line is you should not just dismiss a fund because it is actively managed.

What do you think? Are you an index only investor, actively managed or both?