Second-quarter performance reporting is right around the corner. Peer groups for periods ending June 2012 will be released in a few weeks. Here is my prediction. Check me out. Most large-cap growth managers will underperform their benchmarks for the year, three years and five years. Most large-cap value managers will outperform their benchmarks. The picture will look like the graph below: Growth managers are losers and value managers are winners.

 

 

These results are categorically wrong for two reasons:

 

1.     The benchmarks are wrong. Popular indexes use Price/Book as their primary style classification metric. The book values of distressed financials are grossly overstated so these companies are currently misclassified as value. For more details see Style of Financial Stocks.

 

2.     Peer groups are loaded with biases. One such bias is particularly problematic because no one knows about it. Classification bias makes winners out of losers and vice versa. For more details see Peer Groups Will Mess You Up.

 

Most importantly, do not make a common mistake. Many, including heads of investment manager research, believe that active managers add the most value when their style is out of favor, which is simply not true. The reality is that benchmarks are wrong and peer groups are biased, so performance rankings are worse than useless; they’re downright misleading.

 

Do you use peer groups? Indexes? Were you aware of the myriad problems? Do you care?