Swedroe: SPIVA Survey Continues Passive Winning Streak

Since 2002, S&P Dow Jones Indices has published its S&P Indices Versus Active (SPIVA) Scorecards, which compare the performance of actively managed equity funds to their appropriate index benchmarks.

For the first time, the year-end 2016 U.S. Scorecard includes 15 years of data. The longer time horizon provides us with a more complete measure of the effectiveness of active managers across all categories. Following are some of the highlights from the report:

• During the one-year period ending Dec. 31, 2016, 66.0% of large-cap managers, 89.4% of midcap managers and 85.5% of small-cap managers underperformed the S&P 500, the S&P MidCap 400 and the S&P SmallCap 600, respectively. The worst performance was in midcap value funds, where almost 97% underperformed.
• As you should expect, as we extend the horizon and as the burden of higher costs compounds, the failure rates tend to increase—over the 15-year period ending in 2016, 92.2% of large-cap managers, 95.4% of midcap managers and 93.2% of small-cap managers trailed their respective benchmarks. The worst performance was in small-cap growth, where 99.4% of active funds failed to beat their benchmarks. So much for the argument that small stocks are an inefficient asset class that active managers can exploit. And the only category where fewer than 80% of active funds failed to beat their benchmarks was large-cap value funds, where 78.5% failed to do so.
• Across all time horizons, the majority of managers across all international equity categories underperformed their benchmarks. Over the last 15 years, the least poor performance was in international small-caps, where 18% of active funds outperformed. In the supposedly inefficient emerging markets, just 10% outperformed.
• Highlighting the importance of accounting for survivorship bias, funds disappeared at an astonishing rate. Over the 15-year period, almost 60% of domestic equity funds were either merged or liquidated. Similarly, more than half of global/international equity funds, and almost half of fixed-income funds, were merged or liquidated.

Performance Gap
The SPIVA Scorecard also allows us to see the performance gap—the degree to which active funds underperformed. The following data covers U.S. funds for the 15-year period ending 2016:

• On an equal-weighted basis, large-cap growth, core and value funds underperformed by 1.7 percentage points, 1.6 percentage points and 0.9 percentage points, respectively. On an asset-weighted basis, they underperformed by 1.3 percentage points, 1.4 percentage points and 0.3 percentage points, respectively.
• On an equal-weighted basis, midcap growth, core and value funds underperformed by 3.1 percentage points, 2.1 percentage points and 1.7 percentage points, respectively. On an asset-weighted basis, they underperformed by 2.3 percentage points, 1.6 percentage points and 1.7 percentage points, respectively.
• On an equal-weighted basis, small-cap growth, core and value funds underperformed by 4.4 percentage points, 2.3 percentage points and 1.1 percentage points, respectively. On an asset-weighted basis, they underperformed by 3.5 percentage points, 1.8 percentage points and 0.7 percentage points, respectively. 
• On an equal-weighted basis, real estate funds underperformed by 0.7 percentage points. On an asset-weighted basis, they underperformed by 0.4 percentage points.
• On an equal-weighted basis, multicap growth, core and value funds underperformed by 1.2 percentage points, 1.5 percentage points and 1.3 percentage points, respectively. On an asset-weighted basis, they underperformed by 1.1 percentage points, 0.7 percentage points and 1.3 percentage points, respectively. This indicates that the freedom of multicap funds to move across market capitalization doesn’t translate to outperformance.  

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 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).

Fixed Income
The performance of actively managed funds in fixed-income markets was just as poor. The results below are for the 15-year period:

• The worst performance was in long-term government bond funds and long-term investment-grade funds, as just 3% of active funds beat their respective benchmarks. On an equal- (asset-) weighted basis, they underperformed by a shocking 3.3 percentage points (2.7 percentage points) and 2.2 percentage points (2 percentage points), respectively. Active high-yield funds didn’t fare much better, with just 4% outperforming. On an equal- (asset-) weighted basis, the outperformance was also a shocking 2% (1.7%).
• For domestic funds, the least poor performance was in intermediate- and short-term investment-grade funds. In both cases, 73% of funds underperformed. On an equal-weighted basis, the underperformance was 0.3 percentage points and 0.7 percentage points, respectively. However, on an asset-weighted basis, they managed to outperform by 0.7 percentage points and 0.3 percentage points, respectively. That is possibly explained by their holding longer maturities (taking more risk) than the benchmarks.
• Emerging market bond funds also fared poorly, as 76% of them underperformed. On an equal-weighted basis, the underperformance was 1.4 percentage points. On an asset-weighted basis, the underperformance was 0.2 percentage points.

The SPIVA Scorecards provide powerful evidence on the persistent failure of active management’s ability to generate alpha (risk-adjusted outperformance). 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.