Active Fund Managers Underperform Indexes
Are active fund managers worth their fees? Not according to a newly-released report from S&P Dow Jones Indices that reports on actively managed fund performance.
Actively managed funds did not fare well against indexes in the last 1-,3-, 5- 10- and 15-year spans, meaning investors are better off sticking with passive funds that track the established indexes and don’t charge hefty management fees.
Barely one third of large-cap managers beat the S&P 500, according to the new report. The news worsened farther down the equity scale: 89.4 percent of mid-cap managers and 85.5 percent of small-cap managers also fell short, respectively.
Active managers manage funds, buying and selling individual stocks. Passive funds, on the other hand, track indexes without actively managing individual stocks. Active funds typically carry much higher fees.
Passive Strategies Gain
Investors have been moving steadily into passive strategies. Exchange-traded funds that mostly track indexes took in record cash inflows during the first quarter of this year for both stocks and bonds. Passive funds in 2016 drew a net $508.4 billion while active funds lost $340.1 billion in outflows, according to Morningstar.
The SPIVA U.S. Scorecard from S&P that reports on active fund performance presents an even weaker long-term outlook.
For the first time, the scorecard tracked 15-year performance to present a “complete market cycle.”
In that 15-year period, 92.2 percent of large-cap managers missed their goals, while the number was 95.4 percent for mid-caps and 93.2 percent for small-caps. More than 58 percent of equity funds in the U.S. folded or merged during the 15-year period.
During the one-year period ending Dec. 31, 2016, 66% of large-cap managers, 89.37% of mid-cap managers, and 85.54% of small-cap managers underperformed the S&P 500, the S&P MidCap 400 and the S&P SmallCap 600, respectively. The figures match the one-year performance figures reported in June 2016, except for large-cap managers, who fared better.
Figures over the five-year period did not change markedly from the SPIVA U.S. Mid-Year 2016 Scorecard. For the five-year period ending Dec. 31, 2016, 88.3% of large-cap managers, 89.95% of midcap managers and 96.57% of small-cap managers underperformed their benchmarks.
Market Conditions Affect Performance
Given that market conditions can affect managers’ performance from year to year, the scorecard added rolling three-year relative performance figures from 2003 through 2016. The figures were calculated on a semiannual basis across domestic and global equity categories
Global markets ended the year on a positive note. International large caps measured by the S&P Global 1200 and emerging markets measured by the S&P/IFCI Composite both rallied to end the year with gains of 8.89% and 10.79%, respectively.
Across all time horizons, most managers of international equities underperformed their benchmarks.
Interest Rate Boosts Performance
In December 2016, the United States Federal Reserve raised the interest rate for the second time in 10 years. Managers investing in intermediate- and short-term credit performed the best for the one-year period, with 19.75% and 26.61% underperforming, respectively. The same trend held through the five-year period. The 10- and 15-year periods proved to be difficult for all credit managers.
The strength in high-yield bonds market delivered a positive spillover effect on the leveraged loan sector.
The S&P/LSTA U.S. Leveraged Loan 100 Index posted a 10.88% year-over-year gain. This outperformance proved difficult for actively managed senior loan funds for the one-year period, however. Nearly 82% of funds underperformed the benchmark.
Trends at mid-year 2016 continued through the year. Spreads narrowed, testing high-yield bond market managers. More than 94% of managers ended the one-year period underperforming the index’s performance of 17.13%.
Other Sources Confirm S&P Tracking
The scorecard is discounted by some because S&P sells index products. However, the findings track measures from other Wall Street sources.
JPMorgan Chase reported active managers have performed well at the start of 2017, but the win rate for large cap managers is only 52%, according to CNBC.
Active managers point out that investors have to know how to assess managers, including market conditions, strategy and performance.
Nick Colas, chief market strategist at Convergex, said it is not certain the current scenario will last indefinitely since markets move in cycles. He said a drop in correlations, the tendency of stocks to move in unison that has characterized the current bull market, will help active managers that can capitalize on pricing discrepancies.
Bob Doll, a senior portfolio manager at Nuveen Asset Management, said market conditions are conducive for managers this year. He sees a likelihood small-cap stocks will outperform this year, that global stocks will outperform the U.S., and that value stocks are leading growth by a wide margin.
Investors Must Screen Managers
Investors have to screen managers for various qualities, said Steve Deschenes, product management and analytics director at Capital Group, which manages more than $1.4 trillion in assets, including American Funds.
Deschenes said lower fees and managers who own the investments they endorse are good signs.
It doesn’t matter if 20% of managers beat the market, he said. It matters if you can identify that 20%.
Performance has differed considerably among different strategies, even though all have fallen short of market benchmarks.
Over the past three years, only 4.4% of large-cap growth managers beat the benchmarks, while 11.4% of large-cap value managers managed to do so. The best performance was for multi-cap value funds over a three-year period, posting a 17.8% win rate.
Investors in all fund categories need to consider their options when choosing actively managed funds given the higher costs of these funds and the likelihood the higher costs will deliver better value.