Published: Dec 15, 2016 2:56 p.m. ET
Hard data keeps tripping up the case for active management
Getty Images
It’s not even close: data show passive stock strategies beat active management in the end.
Over the past five years, Wall Street has been in a nearly uninterrupted upswing, giving plenty of gains to the investors who played it simple by investing in passive-based strategies.
On the other hand, for every 100 investors who sought outperformance over that same period through active funds, 99 of them failed.
That passive strategies—where the holdings are pegged to a benchmark, rather than being chosen by an individual or team, as with active funds—outperform over the long term has been repeatedly established by data.
Among those findings, especially when fees are taken into account, a mere 0.81% of domestic equity funds remained in the top quartile of performers over five consecutive 12-month periods, according to S&P Dow Jones Indices. The research firm, which compiled the data and looked at «a sampling» of relevant funds, said those results were actually the best of the bunch. For mid-cap, small-cap and multi-cap funds, the percentage that stayed in the top quartile was nonexistent: 0.0% managed the feat.
The performance was slightly better over a shorter time frame. Over three consecutive 12-month periods, 2.46% of large-cap funds remained in the top quartile of performers, net of fees, while 2.2% of mid-cap funds did and 3.36% of small-cap funds did. Multi-cap funds were the best in class, with 4.08% consistently staying in the top quartile.
The results were better on the fixed-income side, especially among mortgage-backed securities. In that category, 14.29% of funds stayed in the top quartile over three consecutive 12-month periods, while 12.5% did over five periods.
Among other bond categories, a whopping 53.33% of government long bonds stayed in the top quartile over three consecutive 12-month periods, by far the highest percentage of any category. Over five such periods, however, that outperformance vanished: none of the funds stayed in the top.
Similar results were seen in investment-grade long funds and emerging market debt funds, where 16.67% and 6.67%, respectively, were in the top quartile over three years. Over five years, 0% of both categories stayed in the top.
According to a September survey by S&P Dow Jones Indices, 84.6% of active managers in the U.S. large-cap equity space underperformed the S&P 500 in the 2016 period ended June 30.
Now, it is generally accepted that there’s greater potential for active management to perform better in times of volatility or market stress. That’s because managers have the freedom to find bargains, chase gains, or hedge against risk, while passive funds can’t deviate from their benchmarks. Recent market action has some investors thinking that active management could be making a comeback.
According to J.P. Morgan data, 53% of active managers outperformed their benchmark in the third quarter, helped by the volatility that resulted from Britain’s unexpected vote to leave the European Union in late June, and ahead of the early-November U.S. election. That was an anomaly, however; in the second quarter of 2016, only 34% beat their benchmark.