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 Global's researchers 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 noteworthy 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 cousin, 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.

At its core, this Persistence Scorecard is trying to answer a rather straightforward 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 analysis by S&P's researchers. They studied returns for U.S. equity funds from mid-2010 through June 2020, separating such performance data into quartiles (25%) and comparing each fund's returns over subsequent yearly periods. During the initial five-year stretch (mid-2010 to June 2015), S&P's research found "it was more likely for a top-half fund to close its doors or change its style (41.5% combined) than repeat its performance in the top half" in subsequent years.

How inconsistent was active management's outperformance? As you can see from the chart below, a vast majority of surviving fund managers weren't able to keep producing peer-beating returns in the most recent full five-year period reviewed (mid-2015 to June 2020). That's even after adjusting for such shenanigans as survivorship bias and style drift. (It's also worth pointing out that S&P's researchers screened using a fairly low bar -- how many active funds were able to outperform their closest rivals, not their respective indexes.) 

Another sobering finding uncovered by the latest S&P Persistence Scorecard was how quickly any one-year burst in active management's performance tended to erode in subsequent years.

This might seem counter-intuitive. After all, if fund managers were skillful at consistently picking individual stock winners, then they should remain in the top half without much difficulty. 

That clearly didn't turn out to be the case in the four major equity categories (All Domestic Funds, All Large-Cap Funds, All Mid-Cap Funds and All Small-Cap Funds) studied by S&P in this research report. (See bar chart below.) 

Even refining such an analysis to just the top outperformers -- i.e., those managers whose funds scored in the top quartile (25%) of their peers' overall results -- wound up showing a significant erosion in results from the first year through subsequent years.

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 added.

Another warning highlighted in the mid-year 2020 Persistence Scorecard: Chasing returns by trying to ride past "hot" fund managers isn't likely to be a very successful investment strategy over the longer-term. "This report shows that regardless of asset class or style focus, active management outperformance is typically short-lived with few fund managers consistently outperforming their cohorts," noted S&P's researchers.  


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