When faced with the mounting evidence supporting indexing as a superior investment approach relative to an active approach, an investor that follows an active approach may state something along the lines of: “I recognize it is tough to beat the market in highly liquid securities where all information is known BUT (always a BUT) … there are certain areas of the market that are more inefficient and therefore allows a more seasoned investor to spot bargains.” The inefficient areas being referred to usually include small cap and emerging market asset classes. While on the surface this makes sense and sounds like the investor is being open-minded in willing to concede his active approach in certain “more efficient areas” to indexing, the subsequent returns do not bear this out. The results for active managers are just as bad if not worst for the perceived less efficient areas of the market than the more efficient areas.

Barron’s recently featured an article, Passive Portfolios’ Emergence, that details the continual inability of active managers outperforming an emerging market index portfolio over the short and long term. To quote:

“The move into index funds has also proved smart. Over the one, three and five years through May, emerging-markets funds on average lagged behind the benchmark MSCI Emerging Markets Index-over the long haul, by a meaningful two to three percentage points a year.”

Underperforming the markets are the equivalent of leaving money on the table, and when Emerging Markets return over 36% as they did for this past quarter, we need to make sure we capture those returns.