SPIVA: Active vs. Passive: 2016 Standard & Poor's Update

Friday, April 21, 2017 2,000 views

“Given that active managers’ performance can vary based on market cycles, the newly available 15-year data tells a more stable narrative. Over the 15-year period ending Dec. 2016, 92.15% of large-cap, 95.4% of mid-cap, and 93.21% of small-cap managers trailed their respective benchmarks.”


“Across all time-horizons, the majority of managers across all international equity categories underperformed their benchmarks.”


“Funds disappear at a significant rate. Over the 15-year period, more than 58% of domestic equity were either merged or liquidated. Similarly, almost 52% of global/international equity funds and 49% of fixed income funds were merged or liquidated. This finding highlights the importance of addressing survivorship bias in mutual fund analysis.”


“According to the S&P Persistence Scorecard, relatively few funds can consistently stay at the top. Out of 631 domestic equity funds that were in the top quartile as of September 2014, only 2.85% managed to stay in the top quartile at the end of September 2016. Furthermore, 2.46% of the large-cap, funds, 2.20% of the mid-cap funds, and 3.36% of the small-cap funds remained in the top quartile.”


“An inverse relationship generally exists between the measurement time horizon and the ability of top-performing funds to maintain their status. It is worth noting that less than 1% of large-cap funds, and no mid-cap or small-cap funds managed to remain in the top quartile at the end of the five-year measurement period. This figure paints a negative picture regarding the lack of long-term persistence in mutual fund returns.



These are among the many highlights from the 2016 Year-End SPIVA and the December 2016 Persistence Scorecards. As the authors note, the passive vs. active debate has been contentious for many decades. On one side, you have investors who truly believe there are “skilled” managers out there who can accurately and consistently find value hidden from the market as a whole. We place ourselves completely on the opposite side of the spectrum, advising investors to not buy the “snake oil” being pedaled by active managers and instead promote the idea that aligning yourself on the same side of the market via index funds is a better proposition for you over the long haul.

Our advice is based on decades of data and empirical research into capital market performance. In an attempt to better understand how markets work, academic researchers began to test hypotheses on how they believed markets functioned. The overwhelming conclusion is that the capital markets are very efficient and hard to consistently outperform. The SPIVA Scorecards are just another data point that supports this conclusion. If you stack up the evidence on both sides of the active vs. passive argument, there is little debate that passive investing has more empirical support.

Performance Comparisons

U.S. Equity

The table below shows the percentage of a selection of active domestic equity funds that underperformed their respective benchmarks over 1, 3, 5, 10, and 15-year periods ending 12/31/2016.

Fund Category Comparison Index 1-Year (%) 3-Year (%) 5-Year (%) 10-Year (%) 15-Year (%)
All Domestic S&P 1500 60.49 92.91 85.82 82.87 82.23
Large-Cap Growth S&P 500 Growth 89.79 95.62 84.80 95.22 95.18
Large- Cap Core S&P 500 74.56 93.35 87.91 89.43 97.48
Large-Cap Value S&P 500 Value 77.99 88.56 91.48 64.49 78.54
Small-Cap Growth S&P SmallCap 600 Growth 95.96 98.11 97.64 98.01 99.43
Small-Cap Core S&P SmallCap 600 89.47 95.13 97.37 94.32 94.64
Small-Cap Value S&P SmallCap 600 Value 88.89 92.74 94.03 91.75 80.71
Real Estate S&P BMI US REITs 84.04 82.42 85.15 83.91 81.82

The pie charts below show the percentage of active U.S. equity funds that underperformed their respective benchmarks for the 15-year period ending 12/31/2016.

 International Equity

The table below shows the percentage of active international equity funds that underperformed their respective benchmarks over 1, 3, 5, 10, and 15-year periods ending 12/31/2016.

Fund Category Comparison Index 1-Year (%) 3-Year (%) 5-Year (%) 10-Year (%) 15-Year (%)
Global Funds S&P Global 1200 79.71 81.28 85.29 84.26 83.05
International Funds S&P International 700 84.94 71.09 66.95 83.89 89.36
International Small Cap Funds S&P Developed Ex US Small Cap 71.84 75.34 61.90 62.96 82.05
Emerging Markets Funds S&P/IFCI Composite 63.90 83.56 74.73 85.71 89.89

The pie charts below show the percentage of active international equity funds that underperformed their respective benchmarks for the 15-year period ending 12/31/2016.

Fixed Income

The table below shows the percentage of a selection of fixed income funds that underperformed their respective benchmarks over 1, 3, 5, 10, and 15-year periods ending 12/31/2016.

Fund Category Comparison Index 1-Year (%) 3-Year (%) 5-Year (%) 10-Year (%) 15-Year (%)
Govt. Long Funds Barclays US Govt. Long 87.93 98.36 98.78 95.65 96.83
Govt. Intermediate Funds Barclays US Govt. Intermediate 74.07 67.86 81.08 78.18 81.82
Govt. Short Funds Barclays US Govt. (1-3 Year) 63.16 75.00 70.00 76.74 86.00
Ivst. Grade Long Funds Barclays US Govt./Credit Long 75.00 98.04 74.80 96.30 97.44
Ivst. Grade Intermediate Funds Barclays US Govt./Credit Intermediate 19.75 37.65 34.39 58.60 72.60
Ivst. Grade Short Funds Barclays US Govt./Credit (1-3 Year) 26.61 38.16 26.39 64.63 72.73
High Yield Funds Barclays US Corporate High-Yield 94.17 90.91 88.04 96.60 95.92

The pie charts below show the percentage of active bond funds that underperformed their respective benchmarks for the 15-year period ending 12/31/2016.

Survivorship Bias and Style Consistency

Style consistency is extremely important when making performance comparisons between a fund and a benchmark. If an active U.S. Large Cap manager is rotating between growth and value type stocks, then performance comparisons can be skewed. Moreover, because different types of stocks have been known to carry different risk properties (i.e. small-cap and value), style consistency, or style drift, is extremely important to an investor from an asset allocation standpoint.

Further, survivorship bias is an important consideration when making aggregate performance comparisons. Many funds end up being liquidated or merged over the course of their life and their historical performance is subsequently dropped from databases. This bias inflates the overall historical performance of active funds. From a practical standpoint, it is also important for investors to understand the risk associated with potentially finding themselves in a fund that ends up being liquidated, usually due to underperformance.

The table below displays major asset classes as well as the percentage of funds within each asset class that survived and maintained a consistent style over the 15-year period ending December 31, 2016.

Fund Category Survivorship (%) Style Consistency (%)
Domestic Large Cap Funds 34.11 39.44
Domestic Small Cap Funds 51.99 45.67
International Funds 43.33 41.52
International Small Cap Funds 56.41 51.28
Emerging Market Funds 53.93 51.69
Real Estate 60.61 46.97
Govt. Funds 43.41 30.13
Investment Grade Funds 47.97 35.01
High-Yield Funds 51.02 44.90
Average of All Domestic Funds 41.84 39.44
The pie charts below display the percentage of funds that survived over the 15-year period ending 12/31/2016 across all major asset classes as well as the percentage that maintained a consistent style. We also included an average of the asset classes shown in the chart. As you can see, over the 15-year period only one-half of the funds across the major asset classes survived the whole period.

As you can see below an average of 57% of the asset classes shown style drifted over the 15 year period. How are we supposed to properly benchmark a fund that style drifted with a benchmark that did not style drift? As we has often stated, the missing link in investment analysis is proper benchmarking. This style drift also poses significant risks to investors who are looking to maintain a consistent asset allocation based on their individual risk capacity.

These facts pose significant risks to investors who are looking to maintain a consistent asset allocation based on their individual risk capacity.

From a performance comparison standpoint, this can pose a challenge as we are trying to compare the performance of a particular benchmark against a moving target.

Persistence In Top Performers

While the vast majority of active managers fail to outperform their respective benchmarks, there is a small percentage that do. It is important to understand whether or not this outperformance was due to a displayed “skill” or just a result of random luck. The S&P Persistence Scorecard attempts to address this question by examining fund performance over time. If there is persistence in top performing managers, then investors can use past performance as an indicator of future results.

The table below displays the percentage of active managers across all major asset classes that remained in the top quartile in terms of performance for the 5-year period ending September 30, 2016. We also included the percentage of managers that we would expect based on chance alone.

Fund Category Remained in Top Quartile (%) Random Chance Expectation (%)
Domestic Large Cap Funds 0.81 6.25
Domestic Small Cap Funds 0.00 6.25
Govt. Funds 0.00 6.25
Investment Grade Funds 3.95 6.25
High-Yield Funds 1.96 6.25

As you can see, the vast majority of top performers at the end of September 2011 did not remain in the top quartile as of the end of September 2016. What this suggests is that short-term outperformance is random and a result of pure luck. From a practical standpoint, investors cannot rely on past performance as an indicator of who is going to be the next top performer. Does that sound familiar?

Conclusion

The active vs. passive debate will continue as investors will continue to look for the top performers and investment managers will continue to lure them in with short-term outperformance. As this analysis illustrates, the vast majority of active managers across all major asset classes:

a)  Do not outperform their respective benchmarks across multiple time periods

b)  Are either liquidated or merged

c)  Do not maintain a consistent style

d)  Do not remain in the highest quartile of performers

These conclusions are not new and have been consistent for decades. The takeaway for investors is that the odds of finding a winning active investment strategy are slim and a better approach for a successful investment experience is to buy, hold, and rebalance a globally diversified portfolio of index funds.

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