The Persistent Myth of Active Funds in Bear Markets


All too often, we hear the refrain that yes, index funds are great for bull markets, but when the next bear market rears its ugly head, you will want to be in active funds because the manager can anticipate the downturn and move at least some of the fund’s assets to cash, thus cushioning the blow for the fund’s shareholders. While this may sound good, in theory, the actual results of active management simply do not bear it out. Here is what S&P Dow Jones Indices had to say about it in their year-end 2011 Indices Versus Active Funds (SPIVA®) Scorecard:

“Bear markets should generally favor active managers. Instead of being 100% invested in a market that is turning south, active managers would have the opportunity to move to cash, or seek more defensive positions. Unfortunately, that opportunity does not often translate to reality. In the two true bear markets the SPIVA Scorecard has tracked over the last decade, most active equity managers failed to beat their benchmarks.”

Now it goes without saying that out of the thousands of actively managed funds, anyone can do a search on Morningstar and find some that beat their benchmark during a bear market. Four funds that experienced a lower drop than the S&P 500’s 55.3% during the last bear market of 2007-2009 were identified by Steven Goldberg in this Kiplinger article. They are shown in the table below:



While it is certainly nice to avoid having to take the full drop of a bear market, it means very little if you also do not fully participate in the market’s upswings. The same thing can be accomplished by having a portion of your portfolio in low-risk fixed income investments. Thus, to see if these four funds truly delivered above-benchmark performance that could not be attributed to luck, we compared the calendar year returns of these funds to their Morningstar analyst-assigned benchmarks. The results are shown in the Alpha Charts below, and they include all the years for which both the fund and the benchmark data exist. While three of the four had a positive alpha (average return above the benchmark), the variance of the alpha was so high that luck could not be ruled out as the cause based on a 95% confidence level.  In fact, the number of years needed of similar returns to conclude the presence of skill ranges from 121 to 732 years.

To summarize, the next time somebody tells you that you need to own actively managed funds to escape the ravages of the next bear market, politely thank him for the advice and then walk away.