April 28, 2009
Nobody needs an active manager in a bull market — an index fund will do just fine. But active managers earn their keep in bear markets, and the current one represents another chance to see whether they add value.
Standard and Poor’s has been measuring the performance of active managers against their passive counterparts with its S&P Indices Versus Active Funds (SPIVA) studies since 2002, and its latest publication focuses on the bear market of 2008. The study concludes that “the belief that bear markets favor active management is a myth. A majority of active funds in eight of the nine domestic equity style boxes were outperformed by indices in the negative markets of 2008. The bear market of 2000 to 2002 showed similar outcomes.”
The race wasn’t even close. According to the SPIVA study, in 2008 passive indices beat active managers across asset classes and style boxes, with very few exceptions.
Case closed? Not so fast…
While the study offers some interesting insights for the active versus passive debate, its claim that active managers fare worse in bear markets is not supported by the data.
S&P derives substantial revenues from the licensing of its index products. We believe it would be foolhardy to accept their claims without a healthy dose of skepticism, and in this case our skepticism is justified.
We reviewed the SPIVA methodology in November of last year and we noted three methodological weaknesses, none of which have been addressed in the current version:
- S&P relies extensively on equal-weighted or “headcount” analysis, whereby they count the number of funds that outperform a benchmark and the number that do not. A fund with $10 million in assets is given the same weight as a fund with $10 billion in assets. A more meaningful approach is to compare the assets of those funds outperforming their benchmark to those that do not. It would seem fairly easy for S&P to provide this information, which would demonstrate whether (for example) a preponderance of smaller funds were underperforming the benchmark, skewing the results.
- S&P compared their results to only their own indices. S&P is one of at least five major vendors to provide index data. Previous studies have shown that S&P’s indices outperform those of other vendors, thus biasing the results in favor of passive management.
- Data impurities persist within S&P’s universe. Active managers will underperform a properly constructed index by fees and expenses, net of the effect of cash. Looking at 2008 results, cash should have a positive impact on active management performance, lessening the effect of the bear market. Yet, according to the SPIVA data, US equity active managers underperformed the broad-based S&P 1500 index by 221 basis points on an asset-weighted basis. Expense ratios average 80 points for US equity funds, leaving at least 141 basis points of performance unexplained. In a business where managers are hired and fired based on razor-thin degrees of relative performance, this discrepancy is too large to ignore.
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