Swedroe: Another Nail In The Active Coffin

I was recently asked to comment on a March 13 piece by Michael Crook, head of portfolio and planning research at UBS. In the piece, Crook notes that 2014 wasn’t a very good year for active managers. He writes: “Roughly 85% of domestic managers and 70% of international managers underperformed.

Crook went on to add that most active managers have underperformed since the end of the financial crisis, a period of about six years now, and that this isn’t completely unexpected. He then observed that “even Warren Buffett has underperformed 53% of the time on a quarterly basis over the last 20 years.” I’d note that there’s quite a difference between looking at year and quarterly data, but why be picky?

Crook then rightly states that “basing portfolio decisions off of short-term performance is destructive to long-term returns.” He concludes: “Active management relative performance must be judged over a full market cycle to be relevant.” And I agree.

No Long-Term Advantage
Unfortunately, the evidence overwhelmingly demonstrates that the longer the time frame we examine, the smaller the percentage of active managers who outperform becomes. We can see this whether we look at the performance of mutual funds or even pension plans, where plan sponsors hire high-priced consultants to help them identify those future outperformers. Put simply, active management is a loser’s game. It is possible to win, but the odds of doing so are so low that it’s not prudent to try.

Although Crook presented no evidence to support a belief in active management as the winning strategy, given that Crook works for UBS, I thought it worthwhile to turn to our trusty videotape to see how UBS’ lineup of actively managed funds have fared.

On its website, UBS describes its actively managed funds as follows: “Consistent, risk-adjusted results. Our talented, experienced investment professionals adhere to well-established and disciplined processes. Our systematic security analysis and risk management tools, help achieve consistent, explainable results.”

Figure 1 presents the performance of UBS’ eight domestic and international equity funds. The funds cover six asset classes, for which Morningstar has 15 years of returns data. That period is more than sufficient to encompass a full market cycle and, in fact, covers two bull and two bear markets.

We will compare the returns of the actively managed UBS funds to the returns of similar, but passively managed, funds from Dimensional Fund Advisors (DFA). In the interest of full disclosure, my firm, Buckingham, recommended DFA funds in constructing client portfolios over this period. Data is as of March 31, 2015.

7 Out Of 8 Active Funds Underperformed

Note that only one of the eight UBS funds managed to outperform the similar DFA fund. The average return for a UBS portfolio of six equal-weighted asset classes (within which we also equal-weighted the returns of funds in asset classes where UBS had more than one fund represented) was 5.3 percent. The comparable DFA portfolio returned 7.4 percent.

In almost all cases, the passive strategy outperformed the active strategy, which was managed by talented, experienced investment professionals at UBS who adhere to well-established and -disciplined processes. We can say that all UBS’ “systematic security analysis and risk management tools” helped achieve was consistently poor results for the full market cycle over which Crook wants investors to be patient.

This result shouldn’t surprise anyone who is aware of the evidence on the performance of actively managed funds. The only real surprise was that the 2.1 percentage point per year average underperformance was three times the difference in the average expense ratio!

Larry Swedroe is the director of research for the BAM Alliance, a community of more than 150 independent registered investment advisors throughout the country.