Actively managed mutual funds sound like less and less of a good idea in the wake of the financial mess, and it could wind up driving investors to exchange traded funds (ETFs).

Matthew Hougan for Index Universe says that fund managers can sidestep the blow-ups in the market, and can pull out and take cash if need be, whereas index funds stay fully invested, no exceptions. This may sound great, but upon closer inspection, he notes that it falls apart.

As Tom Lauricella for the Wall Street Journal notes, approximately nine out of ten actively managed midcap funds lost to the S&P MidCap 400 over the past year.

In fact, the performance isn’t even close: the average fund is down 23.2%, while the index is only down 16.7%. Among the small-cap funds, fewer than one-in-five has done better than the Russell 2000 Index. In past years, fund managers actually did well in small caps. During the bear market of 2000-20002, roughly 60% of small-cap funds beat the index.

Ironically, that underperformance may have something to do with ETFs. Money pouring into ETFs pushed the thinly traded stocks of an index much higher, while the kinds of stocks owned by fund managers do not move as much.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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