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Why I prefer some active managers to most index funds

According to S&P Dow Jones Indices, a large number of US active managers underperformed the benchmark over 3, 5, 10 and 15-year periods. Indeed, for each of those timeframes more than 80% of funds underperformed the benchmark.

The US benchmarks are tough to beat. The US economy has been a very strong performer and the iShares S&P 500 ETF (ASX: IVV) is full of quality businesses. Some of the best growth businesses are now the biggest, meaning Facebook and Alphabet (Google) could keep powering the S&P 500 higher as they have a larger influence on the overall return.

However, it must be said that the outperformance of the benchmark wasn’t over 100% of funds. Australia’s fund managers performed better compared to the index, but it still wasn’t great.

Whilst I agree that some indexes are tough to beat and worthy of investment, like the S&P 500, I think other indexes are influenced enough by poor-performing businesses that makes them not worth owning, such as Vanguard Australian Share ETF (ASX: VAS).

Vanguard MSCI Index International Shares ETF (ASX: VGS) is a bit better, but for every good holding there is a bad one in its midst.

I certainly don’t believe that every active manager is worth investing in. Like a school child or sportsperson, if they have shown to be good stock pickers then their investment process will likely lead to continued strong performance.

One pick or one fantastic year doesn’t make a great manager. But, if they’ve shown good performance for a sustained period then they are worthy of being considered.

I also like funds where the income distributed can be managed efficiently.

Over the next few years share markets are predicted to be sluggish at best due to the current high valuations and rising interest rates. Not every share goes down, which is why active managers may outperform during this period.

Foolish takeaway

For me, some of the Australian funds that fit my criteria of long-term outperformance and smoothed-out income are MFF Capital Investments Ltd (ASX: MFF), Magellan Global Trust (ASX: MGG), WAM Microcap Limited (ASX: WMI), WAM Research Limited (ASX: WAX) and Naos Emerging Opportunities Company Ltd (ASX: NCC).

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Motley Fool contributor Tristan Harrison owns shares of Magellan Flagship Fund Ltd, MAGLOBTRST UNITS, WAM MICRO FPO, and WAM Research Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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