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In a bear market like we're experiencing now, it seems like any stock you might be interested in owning goes down the minute you buy it. And yet there are millions of investors who are convinced that they can beat the market, either through individual stock picking (not a chance) or through a balanced mutual fund portfolio (better chance).

A recent NY Times article asks the question, "How many mutual fund managers can consistently pick stocks that outperform the broad stock market averages -- as opposed to just being lucky now and then?" The article attempts to answer that question:

Countless studies have addressed this question, and have concluded that very few managers have the ability to beat the market over the long term. Nevertheless, researchers have been unable to agree on how small that minority really is, and on whether it makes sense for investors to try to beat the market by buying shares of actively managed mutual funds.

Yet, there is a new study out that...

...builds on this research by applying a sensitive statistical test borrowed from outside the investment world. It comes to a rather sad conclusion: There was once a small number of fund managers with genuine market-beating abilities, as judged by having past performance so good that their records could not be attributed to luck alone. But virtually none remain today. Index funds are the only rational alternative for almost all mutual fund investors, according to the study's findings.

The study, "False Discoveries in Mutual Fund Performance: Measuring Luck in Estimating Alphas," has been circulating for over a year in academic circles. Its authors are Laurent Barras, a visiting researcher at Imperial College’s Tanaka Business School in London; Olivier Scaillet, a professor of financial econometrics at the University of Geneva and the Swiss Finance Institute; and Russ Wermers, a finance professor at the University of Maryland.

You can read the nitty gritty of the research, but the crux of the story is that fund managers used to be more successful picking stocks that beat the market but have since faded in their ability to beat the market. The reasons for this decline could be due to a number of factors:

Professor Wermers says he and his co-authors suspect various causes. One is high fees and expenses. The researchers' tests found that, on a pre-expense basis, 9.6 percent of mutual fund managers in 2006 showed genuine market-beating ability -- far higher than the 0.6 percent after expenses were taken into account. This suggests that one in 10 managers may still have market-beating ability. It's just that they can't come out ahead after all their funds' fees and expenses are paid.

Another possible factor is that many skilled managers have gone to the hedge fund world. Yet a third potential reason is that the market has become more efficient, so it's harder to identify undervalued or overvalued stocks. Whatever the causes, the investment implications of the study are the same: buy and hold an index fund benchmarked to the broad stock market.

And has this study affected the researchers use of mutual funds?

Professor Wermers says his advice has evolved significantly as a result of this study. Until now, he says, he wouldn't have tried to discourage a sophisticated investor from trying to pick a mutual fund that would outperform the market. Now, he says, "it seems almost hopeless."

Hopeless? Hmmm...just like the stock market feels these days...

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