It continues to be incredibly difficult to generate returns in the stock market that beat (or outperform) a passively managed fund tracking the S&P 500.

According to S&P Dow Jones Indices (SPDJI), 51.2% of U.S. large-cap equity fund managers underperformed the S&P 500 during the first half of 2022 — despite the fact that the S&P itself fell into a bear market during that period.

“Market downturns typically offer abundant hunting grounds for active managers,” Tim Edwards, managing director at SPDJI, said on Thursday. “While actively managed large-cap U.S. equity funds were on track for their best (i.e., lowest) underperformance rate since 2009, still less than half were able to outperform their benchmark in the first six months of 2022, echoing a prevailing SPIVA theme: The majority of actively managed funds are unable to outperform their benchmarks over the long-term.”

For what it’s worth, this is an improvement from 2021, when 85.1% underperformed.

Nevertheless, it follows 12 consecutive years in which the majority of fund managers in this category have lagged the index.

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Past performance is no guarantee of future results 📉

It’s great if you or your money manager are among the minority beating the market in recent periods.

However, outperformers rarely continue to outperform.

According to an SPDJI report published in April, of the 29% of 791 large-cap equity funds that beat the S&P 500 in 2019, 75% beat the benchmark again in 2020. But only 9.1%, or 21 funds, were able to extend that streak of outperformance into 2021.

Mutual fund companies aren’t kidding when they publish that classic disclaimer: “Past performance is no guarantee of future results.”

One stat shows how hard it is to pick market-beating stocks 🎲

There are a lot of reasons it’s difficult to pick the right mix of stocks with the right weightings that’ll beat the market.

One devastating reason is that it’s not a 50-50 shot that the stock you pick will outperform over time.

In a report published last year, SPDJI found that only 22% of the stocks in the S&P 500 outperformed the index itself from 2000 to 2020.

Over that measurement period, the S&P 500 gained 322%, while the median stock rose by just 63%.

It’s also worth noting that if you had a portfolio of stocks consisting of mostly underperformers and a few outperformers, this wouldn’t necessarily mean you’d be underperforming the index.

“This is because stock market returns tend to be positively skewed,” Craig Lazzara, managing director at SPDJI, wrote in that 2021 report. “Rather than being symmetrically distributed around an average, return distributions typically have a very long right tail; a relatively small number of excellent performers has a disproportionate influence on the market’s overall return.”

In other words, if your outperformers are way out on the right tail of the above chart, then they might be generating massive returns that more than offset all of the underperformance of the other stocks.

Unfortunately, no one has a great track record at identifying the stocks that’ll become these “excellent performers.”

Maybe you can’t beat the market, but you can beat most pros 🤯

Taken together, everything you’ve read above makes a very strong case for passive investing, which can be pretty boring.

But in this particular context, boring can be sexy.

Barry Ritholtz, cofounder and CIO of Ritholtz Wealth Management, explained in a recent blog post:

5. Consistent average returns turn into above-average returns over time. Howard Marks has discussed why typical managers who finish in the top 10% in any given year underperform over the long haul. They tend to be narrow and specific, and their sector/style/region goes in and out of favor. Bouncing between the top and bottom deciles is not a formula for long-term performance. Instead, consistently achieving a modest target in the middle will eventually turn in top quartile returns (or better).

This is a brilliant way of thinking about all of these SPDJI studies. If only 9.1% of large-cap equity fund managers beat the S&P 500 from 2019 to 2021, then being in an S&P 500 index fund means you would’ve beat 91% of the pros during the period.

Managing expectations 😬

There’s nothing wrong with investing in specific businesses you believe in or stocks you think offer extraordinary value.

However, if your intention is to beat the market, you should manage your expectations.

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Related from TKer:

• How Warren Buffett’s disciples have evaded the ‘stealth bear market’ 🤌

• 'Past performance is no guarantee of future results,' charted 📊

• One stat shows how hard it is to pick market-beating stocks 🎲

• In the stock market, time pays ⏳

• Warren Buffett's 'fourth law of motion' 📉