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John Reese is CEO of and Validea Capital, and portfolio manager for the National Bank Consensus funds. Globe Investor has a distribution agreement with, a premium Canadian stock screen service. Try it.

While 2014 has been another good – albeit very choppy – year for U.S. stocks, it has been another rough one for mutual fund managers. As of late October, more than 75 per cent of large-cap funds were lagging their benchmarks, according to Morningstar data. Nearly 90 per cent of mid-cap funds lagged their benchmarks, meanwhile, and about half of small-cap funds lagged theirs.

That's nothing new. Numerous studies show that the vast majority of mutual funds fail to beat their benchmarks over the long term. Part of that is because of fees and trading costs. And part of it is due to plain old bad management – buying high and selling low.

Individuals don't do any better. Recent research from Dalbar Inc. shows that individual investors have underperformed the S&P 500 by more than four percentage points a year over the past 20 years.

Given the data showing that pros and amateurs alike fail to outperform the major benchmark indexes, should anyone practise active management any more? Or is passive index investing the only real way to go?

Well, I certainly believe active management can be a very successful approach – if it's truly active. The evidence shows you have to be different from most investors to be successful over the long haul, and being different usually results in difficult short-term periods of relative underperformance.

Consider a study that Patrick O'Shaughnessy recently highlighted in a piece for the American Association of Individual Investors. The study, conducted by Yale professor Martijn Cremers and BlackRock portfolio manager Antti Petajisto, found "that the best way to predict how a fund manager would perform is to look at how unique their portfolio is versus the index; the more unique, the higher the average excess returns," O'Shaughnessy wrote. The study's authors found that funds with high "active share" – a high percentage of holdings that weren't in their benchmarks – outperformed their benchmark indexes by almost 2 1/2 percentage points per year before fees and more than one percentage point after fees.

It makes sense. On a gross return basis, a "closet indexer" – a fund or portfolio that largely mirrors its benchmark's holdings – should perform like the benchmark index, because their holdings are so similar. Factor in fees and trading costs, and their net returns are likely to lag those of the benchmark. To offset the fees and costs, a fund has to beat a benchmark on a gross basis, and to beat it, the fund has to be different from it.

The outperformance of funds with high active share also makes sense on an intuitive level because stocks that aren't in the major benchmark indexes tend to be flying under the radar and getting a lot less attention from Wall Street, making them more susceptible to significant mispricings that fundamentals-focused investors can exploit.

After years of studying history's best investors and all sorts of academic research, I'm confident that a concentrated portfolio can do very well over the long haul, with the price being that there will be a lot of short-term ups and downs.

In the end, I think investors should focus on the best opportunities in the market based on fundamentals and financials. But it's not always as simple as loading up your portfolio with a small number of the most fundamentally and financially sound stocks. There's a real world, practical aspect of investing that you have to deal with, too. You thus have to know yourself, to understand your tolerance for declines and how you'll respond when things get tough – and they will get tough at some point.