Money Balance

S&P Study: Active Funds No Panacea for Managing Risks

Money Balance

A lack of consistency by active fund managers in beating their respective benchmarks has been a constant theme of research over the years from the S&P Indices Versus Active (SPIVA) scorecards.

With roots tracing back to 2002, this benchmarking series in its most well-known form semi-annually reviews data tracking performance of active fund managers against their respective S&P indexes.

Less widely covered is sister research that breaks down returns across different asset classes and categories by applying another filter -- the Sharpe ratio, a metric named after Nobel Laureate William Sharpe. It's designed to compare active fund performance to a relatively "risk-free" investment like a one-month U.S. Treasury bill.

The Risk-Adjusted SPIVA Scorecard, as it's called, also considers how much market volatility active managers expose investors to in pursuit of index-beating returns. To measure fund returns against market gyrations over time, S&P's analysts use standard deviation, a common statistical gauge of an investment's risk. "Our goal is to establish whether actively managed funds are better at risk management than passive indices," the risk-adjusted report's authors wrote.

When applying an efficient frontier analysis -- where gains are judged relative to how much market risk is being injected into a portfolio -- this study's results in the periods tracked raised red flags about the dangers of chasing performance based solely on raw returns.

Below is a graphic illustrating the percentage of domestic stock funds that underperformed their respective S&P indexes across different categories in various timeframes. Such data doesn't paint a pretty picture: After adjusting for risk factors, a majority of actively managed U.S. stock funds in all shapes and sizes produced lagged their 'closest-fit' benchmarks.

And it wasn't even close. As you can see, regardless of periods reviewed -- the past five-, 10- or 15-years (through 2018) -- active managers came up overwhelmingly short. Their "best" performance, according to S&P's report, was in the shortest rolling period studied (five years) in mid-cap domestic funds, where 81.34% of these managers weren't able to generate index-winning risk-adjusted returns. (Also worth noting: this data represents returns net-of-fees.)

Percentage of U.S. Equity Funds Outperformed by Benchmarks
Data as of Dec. 31, 2018 - NET OF FEES (%)

But such data crunching tools work best when comparing investment vehicles generating positively skewed or negatively skewed return patterns -- such as those often found with options-based or commodities trading strategies, according to the S&P report's analysts.

"Since our study universe comprised long-only, '40 Act mutual funds, and for purposes of simplicity and comprehensiveness, we chose the Sharpe ratio to represent risk-adjusted returns," they added.

To more closely figure how much risk active managers exposed investors to in order to capture higher market returns, the risk-adjusted scorecard determined a risk-return ratio. "Through this analysis, we can now observe whether managers, on average, were able to outperform their benchmarks after adjusting for risk and fees," the report observed.

The charts below show a more comprehensive breakdown of the Risk-Adjusted SPIVA Scorecard's results. Of course, this analysis covers rolling 15-year timeframes through 2018.

Percentage of U.S. Equity Funds Outperformed by Benchmarks – Risk-Adjusted Returns
Data as of Dec. 31, 2018 - NET OF FEES (%)
Fund Category Comparison Index 5-Year 10- Year 15-Year
All Domestic Funds  S&P Composite 1500  91.05 92.17 93.91
All Large-Cap Funds  S&P 500  87.58 89.33 92.21
All Mid-Cap Funds  S&P MidCap 400  81.34 83.78 90.88
All Small-Cap Funds  S&P SmallCap 600  88.44 82.93 94.71
All Multi-Cap Funds  S&P Composite 1500  92.04 90.18 93.02
Large-Cap Growth Funds  S&P 500 Growth  95.96 96.7 99.46
Large-Cap Core Funds  S&P 500  91.18 95.61 93.67
Large-Cap Value Funds  S&P 500 Value  77.12 74.39 72.63
Mid-Cap Growth Funds  S&P MidCap 400 Growth  76.88 87.4 92.11
Mid-Cap Core Funds  S&P MidCap 400  86.78 87.22 91.09
Mid-Cap Value Funds  S&P MidCap 400 Value  93.55 83.45 86.84
Small-Cap Growth Funds  S&P SmallCap 600 Growth  87.63 83.91 96.95
Small-Cap Core Funds  S&P SmallCap 600  92.92 89.45 95.51
Small-Cap Value Funds  S&P SmallCap 600 Value  90.65 71.85 85.71
Multi-Cap Growth Funds  S&P Composite 1500 Growth  95.56 98.7 96.85
Multi-Cap Core Funds  S&P Composite 1500  96.66 92.96 92
Multi-Cap Value Funds  S&P Composite 1500 Value  86.87 78.4 85.37
Percentage of International Equity Funds Outperformed by Benchmarks – Risk-Adjusted Returns
Data as of Dec. 31, 2018 - NET OF FEES (%)
Fund Category Comparison Index 5-Year 10- Year 15-Year
Global Funds  S&P Global 1200  87.15 81.2 85.26
International Funds  S&P 700  82.56 80 91.1
International Small-Cap Funds  S&P Developed Ex-U.S. SmallCap  73.68 66.04 75.86
Emerging Markets Funds  S&P/IFCI Composite  92.67 85.96 92.31

"All else being equal, higher risk taken by a manager should be compensated by higher returns," the authors noted. 

This is interesting, they pointed out, since "critiques of passive investing often argue that indices are not risk-managed, unlike active management."

In fact, these S&P analysts warn that from their research in this period -- as well as similar past studies looking underneath the hood of actively managed funds -- hiring an active manager isn't a panacea for investors looking for some magic potion to avoid market risks during tumultuous times. 

"From these reports, we did not see evidence that actively managed funds were better risk-managed than passive indices," the authors concluded.


This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. There is no guarantee investment strategies will be successful. IFA utilizes standard deviation as a quantification of risk, see an explanation in the IFA glossary. Investing involves risks, including possible loss of principal.

1. Source: S&P Dow Jones Indices' Risk-Adjusted SPIVA Scorecard report, released on June 5, 2019.