In 1998, I was a holder of the Legg Mason Value Trust fund, run by Bill Miller. I received a quarterly report dated December 31, 1998 for the fund and two others. I found the report's discussion under the heading, "Some Thoughts on Indexing and Performance" so interesting that I kept it all these years. I was unable to find a link to it, but I am including some snippets from it:
"Most money managers again failed to keep pace with the benchmark S&P 500, which outperformed over 80% of active managers in 1998 and over 95% of active managers over the past five years."
"The S&P 500 is the benchmark for most active managers; it is the competition."
"Surprisingly, scant attention appears to be directed at the methods and strategies of the S&P 500 despite its long-term record of superiority relative to most active money managers."
"Two questions suggest themselves: why does indexing work, and can active managers improve their results by careful study of the competition? The answer to the first question is easy: indexing works because the market is efficient."
"Is active management just a loser's game and passive indexing the only viable investment strategy? Not at all. Just as poorly performing companies can often improve their results by studying winning competitors, active managers can improve theirs by deconstructing the sources of competitive advantage of the index, in our case the S&P 500.
The first and most important feature of the S&P 500 is that it does not employ a passive selection strategy. Managers of index funds employ such a strategy, since they engage in no active stock selection. But the S&P 500 is an actively selected index. Its stocks are chosen from the nearly 9000 publicly traded securities on the New York, American and NASDAQ markets by a committee using specific investment criteria.
The returns of the S&P 500 are the best evidence of the long-term advantage of active portfolio construction. It has consistently beaten broader, passively constructed indices, such as the Wilshire 5000, the Russell 2000, and the NYSE Composite. That it has also beaten other active money managers is not an argument against active management, it is an argument against the methods employed by most active managers.
The S&P 500 is a long-term oriented, low turnover index employing a buy and hold strategy, which is by nature tax efficient. It lets its winners run, and selectively eliminates its losers. It never reduces a successful investment no matter how far up the stock has run, and it does not arbitrarily impose size or position limits on holdings, either by company or industry..."
"The contrast with the typical active manager is stark. The average mutual fund is short-term oriented, has high turnover, is tax inefficient, and employs a trading oriented investment style. Most funds systematically cut back winners or rotate out of stocks that have done well into those expected to do better. Position limits and industry weightings are usually rigidly maintained in the name of either investing discipline or risk control... The overall portfolio is constructed in accordance with some style the manager erroneously believes is likely to outperform the long-term, low turnover approach of the S&P 500."
There is more of interest, but I think the above quotations are the highlights.