Swedroe: ‘The Loser’s Game’ Reaffirmed

January 07, 2019

Since 2002, S&P Dow Jones Indices has published its biannual Indices Versus Active (SPIVA) reports, which compare the performance of actively managed equity funds to their appropriate index benchmarks. It also puts out a pair of scorecards each year that focus on persistence of performance.

This is an important issue, because if persistence is not significantly greater than should be expected at random, investors cannot separate skill-based performance (which might be able to persist) from luck-based performance (which eventually runs out).

The Highlights

Following are some of the highlights from the just-released December 2018 Persistence Scorecard, with data through September 2018:

  • Of the 550 domestic equity funds that were in the top quartile as of September 2016, only 7.09% managed to stay in the top quartile at the end of September 2018 (2.33% as of March 2018). Furthermore, 6.60% (0.93%) of large-cap funds, 3.95% (0%) of midcap funds and 7.69% (3.85%) of small-cap funds remained in the top quartile. Randomly, we would expect 6.3% to do so.
  • For the three-year period ended in September 2018, persistence figures for funds in the top half also improved. Over three-consecutive 12-month periods, 23.64% of large-cap funds, 21.71% of midcap funds and 20% of small-cap funds maintained a top-half ranking—all less than the 25% we would expect to do so randomly.
  • The data show a stronger likelihood for the best-performing funds to become the worst-performing funds than vice versa. Of the 497 funds that were in the bottom quartile, 10.06% moved to the top quartile over the five-year horizon, while 21.13% of the 497 funds that were in the top quartile moved to the bottom quartile during the same period.
  • Over the five-year horizon, the results show a lack of persistence among nearly all the top-quartile fixed-income categories, with a few exceptions.

The bottom line is there was little to no evidence of persistence in performance greater than randomly expected among active equity managers.

The Paradox

The year-end 2017 U.S. SPIVA report showed that over the latest 15-year investment horizon, 92% of large-cap managers, 95% of midcap managers and 96% of small-cap managers failed to outperform on a relative basis when calculating performance data with results from closed funds included.

That’s even before considering that the largest expense for the typical actively managed fund is taxes. Despite the persistent failure of active managers to outperform, as the table from an October 2018 CNBC article shows, active funds of all kinds manage far more assets than passive funds and ETFs.



The good news is that investors are reacting to active management’s persistent failure. 2017 was the fourth-straight year money flowed into passive funds and out of active funds. The table below, from the same October 2018 CNBC article, shows the net cash flows through August 2018.



Lure Of Past Performance

Unfortunately, many institutional investors (such as endowments and pension plans) still engage in the practice of selling funds or firing managers once they have underperformed the market over the previous three years, typically replacing them with funds or managers that have recently outperformed.

They do this while ignoring not only the evidence that past performance has almost no predictive value, but also the research that found the hired managers go on to underperform the fired managers.

An explanation for this seemingly strange outcome involves evidence of mean reversion in mutual fund performance. Robert Arnott, Vitali Kalesnik and Lillian Wu, the authors of the January 2018 study “The Folly of Hiring Winners and Firing Losers” found it can be explained by the tendency of underperforming managers to hold cheaper assets with cheaper factor loadings, setting them up for good subsequent performance, whereas recently winning managers tend to hold more expensive assets.


The SPIVA scorecards provide powerful evidence regarding the persistent failure of active management’s ability to persistently outperform. They also provide compelling support for Charles Ellis’ observation that, while it’s possible to win the game of active management, the odds of doing so are so poor that it’s imprudent to try—which is why he called it “the loser’s game.”

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

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