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Forget drivel about a stock picker's market

It's a stock picker's market.

So we're told on a constant basis by the mutual fund industry these days. Really, what the fund people mean is that you need the services of a skilled money manager to negotiate today's treacherous stock markets. Follow an indexing strategy, where you buy index funds or exchange-traded funds that track the major stock indexes, and you're just asking for trouble.

This is self-serving nonsense -- let's get that straight right now. It's all about selling mutual funds, not providing the kind of advice that helps investment portfolios grow fatter over time.

The idea that only a shrewd stock picker will make money in today's markets is based on an expectation that the major stock indexes are in a stagnant phase that could last a year or longer. The indexes may move up during this period, but then they'll ease back and give up their gains.

No doubt, flat markets are a death valley for index investing, where you basically make whatever the index provides. I wouldn't spend more than a second or two worrying about it, though. In fact, periodic buying of index funds during a flat period could prove wise if you can hold your index funds over many years.

You can use index funds or ETFs to play the market in the short term, but they really come into their own as a long-term investment.

Mutual fund people would say the same about their products, of course. Yet for some reason they're talking a lot these days about a temporary, passing phenomenon known as a stock picker's market.

Maybe it will take veteran savvy to make money in stocks this year. But what about 2003 and the years beyond that? You can absolutely bet that the indexes will find their legs again.

Will fund people get the word out that the stock picker's market is ending and the indexer's market is just beginning? Forget it.

For one thing, the fund industry is largely biased against indexing because it's a competitive threat. This means you can't expect straight talk on indexing from fund companies and many financial advisers who make their living selling funds.

More importantly, the fund industry won't see the indexer's market coming. For that they would need to be effective market timers, and there are damned few of these around.

The proof of this is in the fund industry's long-term performance numbers.

The grand total of U.S. equity funds available to Canadians that have beaten the S&P 500 over the past decade is one (yes, one). Of the 73 Canadian equity funds listed as having a 10-year record on Globefund.com, 36 managed to beat the index.

If you think the Canadian numbers aren't bad, you should realize that they are stacked in favour of funds as opposed to the indexes.

All the dud Canadian equity funds that were euthanized or merged with better funds are not factored into the average numbers. As well, funds were somewhat insulated from Nortel's fall through 2000 and 2001 because they could put no more than 10 per cent of their holdings in the stock. Index funds had a significantly higher exposure to Nortel, although this problem has disappeared with the stock's decline in value.

And what of the stock pickers themselves? There are some smart cookies who will beat the market, but it's hard to find them. So hard, in fact, that many of the people who wrote annual fund selection guides have packed it in.

Then there are the stock pickers who picked stocks such as Enron. Fact is, pros can make the same mistakes as individual investors.

For that matter, stock pickers could also be wrong in their market outlook for 2002. There are solid reasons to believe a flat market is ahead, but it's also conceivable that the big stock indexes will do just fine. All it would take is a good couple of months.

You might get the idea that a funds-versus-indexing schism exists in the investing world, and maybe it's true for those who make their living selling mutual funds, or for that matter ETFs and index funds.

Smart investors ignore the propaganda while seeking a comfortable mix of mutual funds and index funds or ETFs, as well as individual stocks and bonds. Want a simple strategy? Use indexing to build the foundation for your portfolio, and then fill in with carefully chosen mutual funds. Carefully chosen means looking at funds with good numbers over a 10- or 15-year period, not just a lucky year or two.

Above all, forget that drivel about it being a stock picker's market. It's just the fund industry trying to move some inventory.
rcarrick@globeandmail.ca

© 2007 The Globe and Mail. All rights reserved.

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