another example of the perils of actively managed funds

The WSJ has a good article on using etfs for tax swaps, something I have been doing since I began my practice. But in the midst of the article it presents a pretty strong example for not using actively managed mutual funds:

.....Getting rid of a subpar mutual fund? The same harvesting methods apply. Look for an ETF whose contents resemble those of the fund as closely as possible. Dodge and Cox Stock has been popular with investors, but this large-cap-value offering has lost about 40% of its value over the past three years. Part of its misfortune is due to Hewlett-Packard Co., which is down more than 18% so far this year and recently was about 4.6% of the Dodge & Cox fund's portfolio.

Over the past three years, Dodge & Cox Stock has moved similarly to the Russell 1000 index, according to an investor tool called the Best Fit Index on Morningstar.com. Best Fit suggests how closely a fund mirrors a benchmark index. By this measure, 97% of Dodge & Cox Stock's movements copied the index. (To find a fund's Best Fit Index, enter its ticker in the quote search window, click on Ratings & Risk and scroll down.) It would be simple to swap this fund for a Russell 1000 ETF such as iShares Russell 1000 Index, in which H-P is under 1% of assets.

10 year chart of dodge and cox  dodgx

Two things stand out in this description:

1. Choosing a mutual fund based on past performance can turn out to be a pretty mad strategy.Not surprsiingly the money flowed into this fund chasing performance and has fled massively ($8.7 billion between  2007 and august 2010) in response to subpar performance.
2.This actively managed fund tracked 97% of the index yet massvely underperformed. In other words its "alpha" or manager contribution to return independent of the index was extremely negative. And why is that because the manager was confident enough to overweight HP close to 5x more than the index.
3. Further complicating things for an investor: even though folk like Morningstar categorize it as a US large cap value fund  17% of its holdings are in foreign stocks. So much for "style purity".

So an investor favorite produced more risk, less return than the relevant index and at higher cost. Even though this fund should be praised for its very low .5% annual management fee it can't match the  Vanguard Russell 1000 value etf  with a fee of .15%

In other words why bother ?