Active Funds Still Trailing

Active managers continue to struggle against passively managed indexes. Yesterday, S&P Indices released the Mid-Year 2011 results for its S&P Indices Versus Active Fund Scorecard (SPIVA). This report quantifies active manager shortfalls.

The SPIVA Scorecard provides performance comparisons corrected for survivorship bias, equal- and asset-weighted peer averages and measures of style consistency for actively managed U.S. equity, international equity and fixed income mutual funds. The data set used in the analysis was obtained from the CRSP Survivor-Bias-Free U.S. Mutual Fund Database.

Here are a few highlights from the report:

  • Over the past three years, which can be characterized by volatile market conditions, 64.0% of actively managed large-cap funds were outperformed by the S&P 500, 75.1% of mid-cap funds were outperformed by the S&P MidCap 400 and 63.1% of the small-cap funds were beaten by the S&P SmallCap 600.
  • Among international equity categories, 57.0% of global funds, 64.6% of international funds and 80.8% of emerging markets funds were outperformed by benchmarks over the past three years.
  • The latest five-year data for domestic equity funds can be interpreted favorably by proponents of passive management. Indices have outperformed a majority of active managers in nearly all major domestic and international equity categories.

A large number of U.S. equity funds went out of business or merged over the past five years and about half the remaining funds change their investment style. Table 1 highlights the percentage of funds in each size category that survived each period and the number that maintained their style consistency (example: a large growth fund remained large growth fund for the entire time).

Table 1: U.S. Equity Fund Survivorship and Style Consistency

Time Period No. of Funds
at Start
Style Consistency
1 Year 2974 93.2 75.8
3 Years 2246 83.8 57.9
5 Years 2087 74.8 50.5

About 5 percent of all equity mutual funds merge or close over any single year and about 10 percent change style.  About 25 percent merge or close over 5 years and only about half the remaining funds remain style pure. These numbers have been a relatively consistent over the past two decades.

Performance by category is divided into equal weight and asset weight. Equal weight means every fund is considered to have the same amount of weight in the calculation. In contrast, asset weight measures the performance of funds based on the amount of money invested in each fund. A fund with more money receives proportionally more weight than a fund with less money. This tells us how the average investor performed rather than how the average fund performed.  Table 2 has these results.

Table 2: S&P Size Category Performance by Weight

Fund Category 1 Year % 3 Years % Annualized 5 Years % Annualized
All LargeCap  Equally 29.8 2.8 3.0
All LC Asset Weighted 29.2 2.9 2.8
S&P 500 30.7 3.3 2.9
All MidCap Equally 37.4 6.1 5.3
All MC Asset Weighted 36.2 5.8 5.6
S&P MidCap 400 39.4 7.8 6.6
All SmallCap Equally 38.1 7.8 4.3
All SC Asset Weighted 37.7 7.7 5.0
S&P SmallCap 600 37.0 8.2 4.6

The only notable item in Table 2 is the difference between SmallCap equal weight and asset weight. Over the past 5 years, SmallCap funds with the most money invested in them outperformed the S&P 600 Index by about 0.4 percent while the average equal weight small cap fund underperformed.  In every SPIVA report there is going to be at least one category that outperforms. There is no predictive methodology available that can accurately foretell the category.

Table 3 highlights the number of funds by category that outperformed over a 1, 3, and 5 year period. The report itself breaks this data into more specific categories.

Table 3: U.S. Equity Funds that Underperformed S&P Indexes by Style

Category 1 Year (%) Bet
by Index
3 Year (%) Bet
by Index
5 Year (%) Bet
by Index
All LargeCap Funds 60 64 61
All MidCap Funds 67 75 79
All SmallCap Funds 47 63 61
REIT Funds 65 66 70

On average, over a 5 year period, about two-thirds of active funds fail to beat a passive index. This number is very consistent with decades of data that I compiled for my recent book, The Power of Passive Investing.

John Bogle and the Vanguard Group launched the first index fund for individual investors in 1976. Since that time, active managers struggle to keep pace with passive index fund alternatives. Thousands of funds have closed or merged over the years as a result of their underperformance, and only about one-third of the remaining funds were able to beat their benchmark — although not by much.