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S&P Takes Active vs. Passive Debate to New Level with Quarterly Fund Scorecard

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Standard & Poor's says it will begin keeping tabs on nearly 2,000 actively managed mutual funds to measure how they stack up against relevant S&P indexes. The new quarterly scorecard will use more sophisticated techniques to give investors a clearer picture of how active funds are performing relative to their benchmarks.

For example, S&P's methodology takes into account "survivorship bias," or the fact that many poor-performing mutual funds are liquidated or merged out of existence. Most comparative studies don't adjust for fund survivorship bias, which may skew the results in favor of active funds. S&P found that for the 12 months preceding October 2002, 6.5% of all funds have been liquidated or merged. Over the past five years, 16.2% of all funds bit the dust.

S&P will also keep track of asset-weighted returns for each fund group, which may give a better idea of how much performance investors are getting for their dollars. Most active vs. passive comparisons are equal-weighted, in which small funds count as much as larger funds with more assets under management. S&P's asset-weighted fund group returns aren't encouraging for active fund investors. Over the past five years, asset-weighted returns for large-, mid-, and small-cap funds have been worse than equal-weighted returns.

Many advisors and analysts say indexing makes the most sense in the efficient large-cap arena. For the five-year period ending September 2002, the S&P 500 outperformed over 63% of all large-cap funds. However, large-cap funds have made a comeback during the bear market, with 54% besting the index over the past three years.

In the mid-cap territory, it's a landslide victory for the S&P MidCap 400, which outperformed 93% of all mid-cap funds over the five-year period and 83% over the last three years. The index's dominance here is largely due to the fact that S&P requires four consecutive quarters of positive earnings to be eligible for the index. Therefore, the S&P MidCap 400 shunned IPOs and other speculative stocks that moved to mid-cap levels. Also, many mid-cap managers shop in the small-cap territory - they also tend to hold mid-cap stocks that move into the large-cap classification. However, they would have generally been better served staying strictly within the confines of an outperforming mid-cap asset class.

Many point to the supposed inefficiency of the small-cap asset class as an example where active funds should have a leg up on the index. However, S&P found that small-cap managers have a tough time besting the S&P SmallCap 600. The index outperformed 67% of funds over the five-year period, and 71% over the past three years. Again, S&P's profitability requirements helped avoid the carnage in small-caps when the technology bubble burst in 2000. The S&P 600 has also gotten the better of its competitor index, the Russell 2000 - we'll compare these two small-cap benchmarks in an upcoming article.

The table below shows asset-weighted average fund performance for various categories against the relevant S&P index. The full report is available on the S&P website.

Index
1-year
3-years
5-years
Large Cap
S&P/Barra 500 Growth
-19.4%
-16.6%
-1.7%
Large-cap growth funds
-20.0%
-16.0%
-3.2%
S&P 500
-20.5%
-12.9%
-1.6%
Large-cap blend funds
-18.3%
-11.7%
-2.0%
S&P 500/Barra Value
-22.2%
-9.8%
-2.3%
Large-cap value funds
-17.3%
-6.6%
-1.0%
Mid Cap
S&P/Barra MidCap 400 Growth
-6.3%
-0.4%
5.2%
Mid-cap growth funds
-18.0%
-12.7%
-2.2%
S&P MidCap 400
-4.7%
3.4%
5.4%
Mid-cap blend funds
-15.1%
-7.0%
-1.3%
S&P/Barra MidCap 400 Value
-3.4%
7.4%
5.5%
Mid-cap value funds
-10.3%
1.4%
1.5%
Small Cap
S&P/Barra 600 SmallCap Growth
-3.2%
-1.2%
-1.7%
Small-cap growth funds
-15.6%
-10.5%
-3.9%
S&P SmallCap 600
-1.8%
2.9%
0.8%
Small-cap blend funds
-8.2%
-2.9%
-1.1%
S&P/Barra 600 SmallCap Value
-1.1%
4.7%
1.8%
Small-cap value funds
-2.1%
5.3%
2.7%

Source: Standard & Poor's, data as of 9/30/2002, asset-weighted returns for fund groups