Swedroe: Active Funds Whiff Again

Standard & Poor’s publishes its SPIVA report for year-end 2015, and the results are unsurprising.

The year-end 2015 S&P Active Versus Passive (SPIVA) scorecard provides yet another example of why—at least when it comes to the overall results of active management relative to appropriate benchmarks—the past is in fact prologue. Following are some highlights from the recently released report:

Domestic Equities

• Last year, 66.1% of large-cap managers, 56.8% of midcap managers, 72.2% of small-cap managers and 61.9% of real estate investment trust managers underperformed the S&P 500, the S&P MidCap 400, the S&P SmallCap 600 and the S&P U.S. Real Estate Investment Trust index, respectively.
• Over the five-year period ending Dec. 31, 2015, 84.2% of large-cap managers, 76.7% of midcap managers, 90.1% of small-cap managers and 82.6% of real estate investment trust managers lagged their respective benchmarks.
• Over the 10-year investment horizon, again ending Dec. 31, 2015, 82.1% of large-cap managers, 87.6% of midcap managers, 88.4% of small-cap managers and 86.1% of real estate investment trust managers failed to outperform on a relative basis. In addition, less than 77% of active managers underperformed their benchmark in only one of the 18 asset class categories (large-cap value) that Standard & Poor’s examined.
• Over the 10-year period, on an equal-weighted basis, actively managed large-cap funds underperformed their benchmark by 0.9 percentage points, actively managed midcap funds underperformed by 1.4 percentage points, actively managed small-cap funds underperformed by 1.8 percentage points and actively managed real estate funds underperformed by 1.9 percentage points. On an asset-weighted basis, the underperformance was somewhat smaller, at 0.8 percentage points for large-cap managers, 0.8 percentage points for midcap managers, 1.3 percentage points for small-cap managers and 1.2 percentage points for real estate investment trust managers.

Global/International Equities

• For the one-, five- and 10-year periods, 59.5%, 79.0% and 80.4% of global equity fund managers underperformed their benchmarks. While the majority of international developed-market managers outperformed in 2015, over the five-year period, 55.4% underperformed, and over the 10-year period, 79.2% underperformed. Furthermore, the majority of international developed-market small-cap managers were able to outperform their benchmarks over the one- and five-year periods, but 62.5% failed to do so over the 10-year period.
• In emerging markets—a supposedly inefficient asset class where active managers purportedly have advantages—over the one-, five- and 10-year periods, 64.1%, 69.9% and 91.4% of active managers underperformed.
• Over the 10-year period, on an equal-weighted basis, active global equity fund managers underperformed by 0.8 percentage points, active international managers underperformed by 0.8 percentage points, active international small-cap managers outperformed by 0.2 percentage points and active emerging market managers underperformed by 1.6 percentage points. The figures were better for active funds on an asset-weighted basis, with global managers matching their benchmark, international funds underperforming by 0.1 percentage points, international small-cap managers outperforming by 0.6 percentage points and emerging market managers underperforming by 0.9 percentage points.

Fixed Income

• Active bond funds didn’t perform any better. For example, over the 10-year period, 95.6% of active long-term government bond fund managers underperformed (doing so on an equal-weighted basis by 2.9 percentage points), 77.1% of active intermediate-term government bond fund managers underperformed (doing so on an equal-weighted basis by 0.3 percentage points), 77.1% of active short-term government bond fund managers underperformed (doing so on an equal-weighted basis by 0.3 percentage points) and 81.3% of active mortgage bond fund managers underperformed (doing so on an equal-weighted basis by 0.7 percentage points).
• While the high-yield bond market is often considered to be best accessed via active investing, the 10-year results show that more than 90% of actively managed high-yield bond funds underperformed their broad-based benchmark. On an equal-weighted basis, the underperformance was 1.4 percentage points (7.0% versus 5.6%).
• Funds continue to disappear at an alarming rate. For example, over the past 10-year period, 40% of domestic and global equity funds, and 37% of international developed market equity funds, were merged or liquidated—highlighting the importance of addressing survivorship bias in mutual fund analysis.

Conclusion

While the above data is compelling evidence on the failure of the active management industry to generate alpha, it’s important to note that all of the above figures are based on pretax returns. Given that the higher turnover of actively managed funds generally makes them less tax efficient, on an after-tax basis, the failure rates would likely be much higher (taxes are often the highest expense for actively managed funds).

The SPIVA scorecards certainly do provide us with valuable information, but there is no longer any suspense in reading them. As Yogi Berra famously said, “It’s deja vu all over again.”

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.