Large-scale studies have shown that actively managed funds underperform their passive benchmarks on an absolute basis. New research shows that this is also true on a risk-adjusted basis – and this is true across asset classes and sub-classes.
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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. While their SPIVA scorecards persistently demonstrate that large majorities of active funds underperform their benchmarks (even before considering taxes) in absolute returns, they do not address the claim that active funds may be superior to passive investment after adjusting for risk. With that in mind, using standard deviation as the measure of risk, they developed a risk-adjusted scorecard.
Following is a summary of their 2019 report:
- Over the last five-, 10- and 15-year periods, 84%, 97% and 92%, respectively, of actively managed large-cap funds underperformed their benchmarks.
- Over the last five-, 10- and 15-year periods, 65%, 80% and 86% of actively managed mid-cap funds underperformed their benchmarks.
- Over the last five- , 10- and 15-year periods, 77%, 89% and 87% of actively managed small-cap funds underperformed their benchmarks – exposing the myth that active management works in the supposedly inefficient asset class of small-cap stocks.
- As in the U.S., the majority of international equity funds across all categories generated lower risk-adjusted returns than their benchmarks. For example, over the five-, 10- and 15-year periods, 75%, 80% and 89% of actively managed emerging market funds underperformed – exposing another myth that active management works in the supposedly inefficient asset class of emerging markets. Similar results were found with international small-cap funds, where 78%, 63% and 68% underperformed.
- A large majority of actively managed fixed-income funds in most categories underperformed over all three investment horizons. At the 15-year horizon at least 60% of active funds underperformed in all categories, and in only two of 14 categories fewer than 78% underperformed. The worst performance came in the supposedly inefficient asset class of emerging-market debt, where over 10- and 15-year periods not a single active fund outperformed. Over the five-year period, 98% failed to outperform.
The authors concluded: “We did not see evidence that actively managed funds were better risk-managed than passive indices. Actively managed domestic and international equity funds across almost all categories did not outperform the benchmarks on a risk-adjusted basis.”
These findings are consistent with those from academic research on the question of persistence in performance. For example, the study by Eugene Fama and Kenneth French, Luck versus Skill in the Cross-Section of Mutual Fund Returns, published in the October 2010 issue of The Journal of Finance, found fewer active managers (about 2%) were able to outperform their three-factor (beta, size and value) model benchmark than would be expected by chance. Stated differently, the very best-performing traditional active managers have delivered returns in excess of the Fama-French three-factor model. However, their returns have not been high enough to be confident in concluding they have enough skill to cover their costs or that their past performance will persist. Fama and French concluded: “For (active) fund investors the simulation results are disheartening.”
Read the full article here by Larry Swedroe, Advisor Perspectives
