Swedroe: Active Mgmt. Delivers Usual Results

While none of us has that perfectly clear crystal ball allowing us to accurately forecast the future, I always feel pretty safe in predicting that the results of Standard & Poor’s next active versus passive scorecard (SPIVA) will be extremely similar to the findings in its prior reports.

Equity Fund Results

And true to form, the just-released 2014 year-end SPIVA review again provides a good 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 of the highlights from the report:

• In 2014, 86.4 percent of domestic large-cap funds underperformed their benchmark, the S&P 500 Index. Over five- and 10-year periods ending 2014, 88.7 percent and 82.1 percent of large-cap funds, respectively, failed to deliver incremental returns over the benchmark.
• In 2014, 66.2 percent of midcap funds underperformed their benchmark, the S&P MidCap 400 Index. Over five- and 10-year periods, 85.4 percent and 89.7 percent of midcap funds, respectively, failed to deliver incremental returns over the benchmark.
• It’s often argued that active managers outperform the indexes in the informationally less efficient market for small-cap stocks. The evidence says otherwise. In 2014, 67.9 percent of small-cap funds underperformed their benchmark, the S&P SmallCap 600 Index. Over five- and 10-year periods, 89.3 percent and 88.1 percent of small-cap funds, respectively, failed to deliver incremental returns over the benchmark.
• The evidence is the same when we look at value and growth funds. Over the 10-year period, 58.8 percent of large-cap value funds, 85.7 percent of midcap value funds and 86.6 percent of small-cap value funds underperformed their benchmark. For growth funds, the respective 10-year figures for underperformance are 89.5 percent of large-cap funds, 91.8 percent of midcap funds and 91.7 percent of small-cap funds.
• REIT funds performed no better. In 2014, 80.1 percent of active REIT funds managed to underperform their benchmark, the S&P U.S. Real Estate Investment Trust Index. Over five- and 10-year periods, 91.5 percent and 78.1 percent of funds, respectively, underperformed the benchmark.
• Based on equal-weighted returns, over the 10-year period, active large-cap funds underperformed the S&P 500 Index by 0.86 percentage points (7.67 percent versus 6.81 percent), active midcap funds underperformed the S&P MidCap 400 Index by 1.55 percentage points (9.71 percent versus 8.16 percent), active small-cap funds underperformed the S&P SmallCap 600 Index by 1.65 percentage points (9.02 percent versus 7.37 percent), active multicap funds underperformed the S&P Composite 1500 Index by 1.18 percentage points (7.89 percent versus 6.71 percent) and active REIT funds underperformed their benchmark by a shocking 1.73 percentage points. A belief in active management as the winning strategy once again proved to be expensive.
• On an asset-weighted basis, the results were somewhat better in that the underperformance was less in each case. Active large-cap funds underperformed their benchmark by 0.64 percentage points, active midcap funds underperformed by 1.05 percentage points, active small-cap funds underperformed by 1.05 percentage points, active multicap funds underperformed by 0.45 percentage points and active REIT funds underperformed by 1.07 percentage points.
• The results were similar for active international funds. Over one-, five- and 10-year periods, 76.9 percent, 75.5 percent and 79.2 percent of active global funds, respectively, underperformed their benchmark, the S&P Global 1200 Index. For international funds, the percentages of active funds that underperformed their benchmark, the S&P 700, were 68.9 percent, 62.5 percent and 84.1 percent, respectively. For international small-cap funds, the percentages of active funds that underperformed their benchmark, the S&P Developed ex-U.S. Small Cap Index, were 69.4 percent, 51.9 percent and 58.1 percent, respectively. And for those supposedly inefficient emerging markets, the percentages of fund active funds that underperformed were 68.7 percent, 72.2 percent and 89.7 percent, respectively.

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 figures cited 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 because taxes are often the highest expense for actively managed funds.

Bond Fund Results

In what won’t come as much of a surprise, the results for actively managed bond funds were similar:

• Over the 10-year period, there were just two bond categories where a slight majority of active funds outperformed—49.1 percent of active intermediate-term bond funds were outperformed by their benchmark and 46.1 percent of global fixed-income funds were outperformed by their benchmark. On the other hand, in other categories, large majorities of active funds underperformed. For example, 95.5 percent of active long-term government bond funds, 97.1 percent of active long-term investment-grade bond funds, 93.0 percent of active high-yield funds, 85.0 percent of active California Municipal Bond funds and 94.3 percent of active New York Municipal Bond funds underperformed their respective benchmarks.
• In some cases, the equal-weighted underperformance was very high. For example, active long-term government bond funds underperformed by 3.32 percentage points (7.48 percent versus 4.16 percent), active long-term investment-grade bond funds underperformed by 2.23 percentage points (7.37 percent versus 5.14 percent), active high-yield funds underperformed by 1.54 percentage points (7.74 percent versus 6.20 percent) and active emerging market debt funds underperformed by 1.45 percentage points (7.82 percent versus 6.37 percent).