Step 3: Stock Pickers updated

Luck or Skill: Evidence from S&P's Persistence Scorecard

Step 3: Stock Pickers updated

Besides tracking active fund managers against their respective benchmarks in the SPIVA Scorecard series, S&P's indexing analysts also biannually compare how consistently top-performers in one period are able to keep producing winning records in subsequent years. 

It's known as the U.S. Persistence Scorecard and serves as an extension of S&P Dow Jones Indicies' SPIVA (Standard & Poor's Indicies versus Active) report. Both of these research series are unique in that S&P's analysts scrub results for so-called survivorship-bias. Such a bias amounts to a statistical shell game played by active managers in which old funds are merged or shuttered, yet performance data doesn't take such manifestations into account.

Like its older SPIVA brother, S&P's Persistence Scorecard also considers how often active fund managers shift their investment focus. This is known in the industry as "style drift," and can skew comparisons between competitors in similar categories.

For example, the latest Persistence report finds that 29% of U.S. equity funds from 2010-2019 drifted between styles, while 10% merged or liquidated. In fact, dividing this period in half shows that more domestic managers either flip-flopped between styles or closed (39%) than produced top-quartile performances (21%) during the 2010s. 

The Persistence Scorecard answers a very simple question: If we have an active fund that was in the top half of its peer group over the prior year, what are the odds that it will remain there in subsequent time periods? The answer is pretty stark, according to the latest persistence numbers analyzed by S&P researchers. 

Managers were screened using a fairly low bar -- how many were able to outperform at least half of their fund rivals. Those landing in each fund group's top half in the first year were then compared to relative outperformers in the next year. Such an analysis was applied over subsequent 12-month periods to consider five straight years.

As you can see in the chart below, no matter what asset class is considered, a vast majority of active funds didn't show much in the way of consistency in terms of generating outperformance. And that's over a rather short five-year timeframe.

If the active managers are skillful at consistently identifying and exploiting inefficiencies in the financial markets, then they should remain in the top half without any difficulty.

On the other hand, if these managers were operating in a highly efficient market in which outperformance was attributable to luck, then investors would expect 50% to remain in the top-half in the first subsequent year, 25% to remain in the top half for both of the next two years, and so on.

That clearly didn't turn out to be the case observed by S&P's researchers in this study. (See bar chart below.) 

Even refining our focus to just the top outperformers -- i.e., those whose funds scored in the top quartile (25%) of their peers' overall results -- wound up worse than "what random chance would predict," S&P's analysts observed.

The chart below reinforces a view of how any spurt of outperformance by active stock pickers is based primarily on luck, not skill.  

Whether measured by the top 25% or more broadly (top half), the authors of this report note that persistence in outperformance tends to be greater over shorter investment horizons. Still, across equity asset-classes "this persistence was inconsistent and decayed over time," they add.

Another warning highlighted in the full-year 2019 Persistence Scorecard: Chasing stocks across different styles isn't a tactic confined to any specific type of active manager or those producing lower-quartile returns. "Top, middle and bottom performers within a category," S&P reports, "all generally had similar chances of style drift over three- and five-year periods." 


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