Breaking news: Mutual fund managers keep failing to beat the market

Standard & Poor's released its latest Indices Versus Active Funds Scorecard today, and the headline result is the same one delivered by almost every study of mutual fund performance since the 1960s: Most actively managed mutual funds underperform the market. To be precise, 66.21% of actively managed domestic stock funds underperformed the S&P Composite 1500 Index in the five years from 2004 through 2008. During the previous five-year period, a smaller majority—50.76%—had underperformed.

But here's something that struck me as odd in the S&P 500's results: Large cap funds did better in relation to their benchmark than their mid-cap and small-cap brethren did. This was true from 2004 through 2008, and it was true from 1999 through 2003. You'd expect the market for large-cap stocks to be more efficient—and thus presumably harder for a fund manager to outwit—than those for mid- and small-cap stocks. There's far more information available about large-cap stocks. Large-cap funds are bigger and more numerous than their smaller-cap counterparts. So they ought to find it harder to beat the market.

Yet they don't. That is, most of the large-cappers still can't beat the market. But 85.45% of small-cap managers underperformed the S&P SmallCap 600 from 2004-2008 and 79.06% of mid-cap managers underformed the S&P MidCap 400, while 71.90% of large-cap managers underperformed the S&p 500. From 1999 through 2003 the difference was even more pronounced: 53.41% of large-cap funds trailed the market, while 91.36% of mid-cap funds and 69.38% of small-cap funds did.

I called Vanguard founder Jack Bogle, who has spent an inordinate amount of time over the past decade digging through mutual fund performance data, and asked him to explain this strange result. He first gave me an earful about how dodgy mutual fund performance data is–mainly because the worst-performing funds go out of business, a bias that researchers try to correct for but are unable to do perfectly. Also, the data aren't dollar-weighted: It's entirely possibly that small-cap managers do just as well on a per-dollar basis as the large-cap guys. You just can't tell. "It makes you conscious of the inadequacy of statistics," Bogle said.

But then he went out on a limb and offered this explanation: "Yes, less-efficient markets make it easier to win. But less-efficient markets make it easier to lose, too." While large-cap funds converge toward mediocrity, small-cap performance is all over the place. There are often some really big winners in the small-cap world, leaving precious few spoils for the rest to divvy up.

Then there's cost. In general, Bogle said, "fund managers tie the market before costs and lose after costs." Small-cap investing is more costly, therefore small cap investors as a group are more likely to trail the market.

So there you have it. It may be easier to beat the market investing in small-cap stocks. But your average actively managed small-cap mutual fund still won't succeed at it.