Actively Managed Funds Fail When Needed the Most

Advisors had little use for actively managed funds over the recent bull market; index funds did exceptionally well. But just when those actively managed funds were most needed – over the recent market downturn – they failed to protect investors.

Since 2002, S&P Dow Jones Indices has published its S&P Indices Versus Active (SPIVA) scorecard, which compares the performance of actively managed equity mutual funds to their appropriate index benchmarks. The 2019 report highlights the performance of active funds over the full decade as well as the last 15 years. Following are some of the most significant data points:

Over the decade, 89% of large-cap funds, 84% of midcap funds and 89% of small-cap funds underperformed their respective passive benchmarks.

Over the decade, the vast majority of both value and growth managers underperformed their respective benchmarks – large cap (90%, 92%), midcap (78%, 88%) and small cap (82%, 97%).

Active long-term government bond funds had almost a perfect record, as 99% failed to outperform over the past 10 years – along with 80% and 70% of intermediate and short-end bond funds, respectively.

More than 97% of high-yield and investment-grade long funds fell short of their benchmark over the decade, though roughly half of investment-grade intermediate and short-term funds did outperform.

Over the 15-year period, on an asset-weighted basis, large-cap funds underperformed by 1.06%, midcap funds by 1.36%, small-cap funds by 0.94% and multi-cap funds by 0.45%. In each market-cap category, both value and growth funds underperformed. In addition, real estate investment trust (REIT) funds underperformed by 1.08%.

International results were similar over the 15-year period. Global funds underperformed by 83.2% (0.54% on an asset-weighted basis), international funds by 90.4% (0.52% on an asset-weighted basis), international small funds by 68.4% (0.28% on an asset-weighted basis) and emerging market funds by 90.6% (0.89% on an asset-weighted basis), destroying the myth that active management works in so-called inefficient markets like emerging markets.

Over the 15-year period, 98.2% of long-term government bond funds underperformed (by a shocking 3.02%), 89.1% of intermediate-term government bond funds underperformed (by 0.67%), 83.3% of short-term government bond funds underperformed (by 0.65%), an almost perfect 99.2% of high-yield funds underperformed (by 2.1%), 93.8% of mortgage-backed securities (MBS) funds underperformed (by 0.71%), and 93.3% of emerging market bond funds underperformed (by 2.31%). All figures are on an asset-weighted basis.

Highlighting the importance of survivorship bias that appears in many rankings (such as Morningstar’s), fund liquidation numbers across equity segments regularly reached into the 60% range over a 15-year horizon, and 40% were sent to the mutual fund graveyard over the past decade. International equity funds posted similar results. In the fixed income arena, about 30% of funds in most categories were merged or liquidated over the decade.

Active management in bear markets

Given that we have just experienced a huge drawdown in equities, it’s worth examining how active management has performed in bear markets. We can begin by first examining the performance of Vanguard’s S&P 500 ETF (VOO). Year-to-date through April 3, 2020, the fund had outperformed 66% of its peers over the course of 2020.

Thanks to Vanguard’s research team, we can examine the performance of actively managed funds during bear markets. Their study, which appeared in the Spring/Summer 2009 issue of Vanguard Investment Perspectives, covered the period 1970-2008 and defined a bear market as a loss of at least 10%. The period included seven bear markets in the U.S. and six in Europe. Once adjusting for risk (exposure to different asset classes), Vanguard reached the conclusion that “whether an active manager is operating in a bear market, a bull market that precedes or follows it, or across longer-term market cycles, the combination of cost, security selection, and market-timing proves a difficult hurdle to overcome.” They also confirmed that “past success in overcoming this hurdle does not ensure future success.” Vanguard was able to reach this conclusion despite the fact that the data was biased in favor of active managers because it contained survivorship bias.

The only really surprising fact is that the myth that active management protects you from bear markets persists. Long ago William Sharpe demonstrated that anyone who can do simple arithmetic can understand that regardless of the asset class or whether there is a bull or bear market, in aggregate active managers must underperform simply because they have greater costs.

Summary

The SPIVA scorecards continue to provide powerful evidence of the persistent failure of active management’s ability to generate alpha (risk-adjusted outperformance). In particular, they serve to highlight the canard that active management is successful in supposedly inefficient markets like small-cap stocks and emerging markets.

The scorecards also provide compelling support for Charles Ellis’ observation that while it’s possible to win the game of active management, the odds of doing so are so poor it’s not prudent to try – which is why he called it “the loser’s game.” And it’s why we continue to see a persistent flow of assets away from actively managed funds.

Larry Swedroe is the chief research officer for Buckingham Strategic Wealth and Buckingham Strategic Partners.

Actively Managed Funds Fail When Needed the Most

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