Active Managers and Under-Performance

Index Funds vs. Actively-Managed Funds

2015 SPIVA
Percentage of funds that UNDER-PERFORMED Benchmark. McGraw Hill Financial

Here are some chilling statistics from SPIVA U.S. Scorecard for investors who pay for advice from professional money managers. This scorecard tracks how well professional money managers perform when compared with investments that  require no active management (i.e., index fund or ETF).

Results for One Year

For the year ending December 31, 2015, the S&P Composite 1500 Index returned 1.01% while the S&P 500 Index posted a 1.38% gain on a total return basis.

During the same period:

  • 66% of large-cap managers underperformed the S&P 500 Index.
  • 56% of mid-cap managers underperformed the S&P MidCap 400 Index.
  • 72% of small-cap managers underperformed the S&P SmallCap 600 index.

It is important to remember that these fund managers are not bashful when it comes to collecting fees. The fact that they cannot do better than their passively managed competitors does not seem to bother them. 

Multi-Year Comparisons

The numbers get worse when considering data for longer-term investments. In fact, these numbers are dismal. 

Over the most recent five-year period

  • 84% of managers of large-cap funds,
  • 77% of managers of mid-cap funds,
  • 90% of managers of small-cap funds lagged their respective benchmarks.

Similarly, over the most recent 10-year period

  • 82% of large-cap managers,
  • 88% of mid-cap managers,
  • 88% of small-cap managers failed to beat their benchmarks.

NOTE: Many mutual Funds go out of business (or merge with other funds) as they build up track records that are unattractive.

As a result, people who examine the data are subject to a survivorship biasTranslation: When people who conduct the studies examine data, they only look at funds that are still in business. Therefore, closing a poorly-performing fund removes that fund and all of its data from consideration. As a result, the performance data is skewed higher simply because some negative data was removed.

 When a fund is performing poorly, it is attractive for the management company to close the fund and pretend that it never existed. When the management company advertises its results, the numbers are improved. it is much prettier to list funds that have done well, rather than including underperforming funds.

During the most recent 5-year period, 23% of US stock funds, 22% of global and overseas equity funds, and 17% of fixed income (i.e., bonds) funds ceased to exist. 

Why You Should Care

This picture is very unfortunate for most mom-and-pop investors because they generally seek investment advice from a retail broker (they do not know where else to turn). The brokers often encourage their customers, especially naive clients who are new to investing and require a lot of attention, to invest in a variety of actively managed mutual funds for the simple reason that these tend to be load funds (i.e., the broker earns an upfront sales commission). Even more sinister, brokers promote funds managed by their own brokerage company because the sales commissions are higher.

Thus, not only are people who need good investment advice not receiving it, but they are steered towards investments that benefit the broker, rather than the investor.

Then they pay an annual management fee to the people who manage the fund. That would not be bad -- if the managers earned their fees. However, the data presented above clearly shows that most fund mangers cannot do as well as the benchmarks. Investors deserve better.

If you are a passive investor -- i.e., if your plan is to buy professionally-managed investment funds and hold onto them for years (decades?), then there is no reason for you to pay for professionals to manage your money. Sure, there have been some spectacular results from very talented managers. (Peter Lynch at Fidelity Magellan Fund in the 1980's is one example. He earned 29% per year for 13 years.) However, the evidence is clear that passive investors are better served by owning shares of investments with very small management fees.

Passive investing is not for everyone, but if that suits your style, I urge you to consider index funds and exchange-traded funds (ETFs) with management fees near 0.05%, rather than actively managed funds where fees are 20x higher and average about 1% per year. 

Back to 2015

During 2015 market conditions were good for growth investing, as demonstrated by comparing the returns of indexes that measure the performance of growth stocks with the results of indexes that measure the investment returns from value stocks.  For 2015, growth stocks did better than value stocks.

Definitions: GROWTH funds own stocks whose future prospects are positive. Such businesses add value for investors by continuing to grow revenues and earnings in the years ahead. That leads investors to bid stock prices higher. VALUE funds buy stocks that have solid fundamentals and are currently priced below stocks of their peers, based on analysis of price/earnings ratio, yield, etc. These companies earn returns for investors when others recognize that the stocks are undervalued and bid them up to higher prices. This process can occur quickly, but it may require a lot of patience. 

The results for growth funds were disappointing in 2015 (growth funds vs. value funds) because:

  • Most actively managed, small-cap and mid-cap, value funds showed better results than their benchmark indices. 
  • Most growth funds under-performed their benchmarks.
  • Growth funds tend to be more actively traded than value funds.

There are explanations as to why certain funds performed better than others, and that information is important to investors who buy such funds. However, the discussion here is to illustrate the relative performance of actively managed funds when compared with the performance of benchmark indexes and there is no reason to try to analyze why it occurred. Interested readers can find such discussions elsewhere. To find appropriate links, Google: "SPIVA US scorecard."

Index funds never try to do better than there benchmarks because their goal is to match (as closely as possible) the results of those benchmarks. Thus, they buy a stock portfolio and only make trades when the composition of the benchmark index changes. There is no risk of trading too often (paying extra commissions and losing money to slippage -- overcoming the bid/ask spread differential). That small difference makes a big difference to an investor's portfolio -- especially when the investment is held for many years.