SPIVA: the evidence against active funds

The chief attraction of active fund management is the prospect that these investing superstars can beat the market for you. Yet one of the most powerful counters levelled against them is that they mostly fail. How do we know they fail? Enter the S&P Indices Versus Active Funds (SPIVA) study that scores active management vs the market.

The SPIVA research reveals two important pieces of evidence:

The vast majority of active funds trail the performance of market benchmarks over ten years.

The funds that do outperform are unlikely to maintain their hot streak. 

Let’s consider the key SPIVA findings that are relevant to UK investors.

Active funds outperformed by benchmarks over 10 years

Source: S&P. “SPIVA Europe Scorecard Year-end 2021.” 10-year risk-adjusted returns. GBP funds.

The outcome is overwhelming. 

The majority of active funds fail to win (green wedges) against relevant market benchmarks over a reasonable investing timeframe. 

This means of course that most active funds aren’t beating index funds and ETFs, either. Remember: index trackers seek to match their particular market (described by a benchmark) minus costs. 

Active funds cost more. So they’ll trail index trackers if they don’t leave the market choking in their dust. 

Same old story

The SPIVA study was first published in 2002. It has been updated regularly ever since. And the results are damning every year. 

The only rational conclusion? Backing active funds versus the market these days makes about as much sense as putting your money on a chess grandmaster versus an Artificial Intelligence. 

The prestige still enjoyed by active funds is a similar relic of a bygone age. It persists because we love to back a human with a compelling story. 

I suppose the pie charts do reveal a kernel of truth to the claim that active managers can better uncover opportunities in smaller and less efficient markets. 

But even in UK equity, where a substantial minority of funds outperform, the majority do not. 

Sic transit gloria fund-y

But this is all doomster talk surely? Why can’t we just pick today’s winners and ride them to glory?

Never mind that ‘Past performance does not guarantee future results’ old pony plastered around the documents by some gloomster regulator with EU sympathies.

Why don’t we just own the minority of funds that have already proven they can deliver?

Let’s reality-check that notion with the S&P Persistence Scorecard. This tracks the ability of active fund managers to maintain a winning streak.

% of active funds in top quartile for four consecutive years 

Source: S&P. “SPIVA Europe Persistence Scorecard Year-end 2021.”

The chart shows that retaining your place in the top 25% is a contest played with more ferocity than Squid Game. 

After just four years, only a sliver of active equity funds remained near the top of their league table:

Europe equity: 2.77%
Eurozone equity: 1.45%
Global equity: 4.31%
Emerging Markets equity: 1.3%
US equity: 1.41%
UK equity: 3.57%

Hmm. Perhaps the casualty rate is less brutal if you restrict the analysis to funds with a three-year outperformance record?

Can those best funds continue to beat their benchmarks for the next three years?

Not so much…

Outperformance persistence over three consecutive years

Equity sub-asset class
Total funds
Funds outperforming 2018
Same funds still outperforming 2021

Global
1075
70
6

UK
358
79
37

US
289
27
1

Europe
1030
166
23

Emerging Markets
322
45
0

Eurozone
569
69
10

Source: S&P. “Europe Persistence Scorecard Year-end 2021.” 

Only UK equity has a halfway respectable percentage of its 2018 winners still winning in 2021 – 47%.1

Global equity winners are scythed down to 9%. The US has only 4% of its 2018 market-beaters still standing. The Emerging Markets have none. 

Active fund management sees more reversals of fortune than a Russian Roulette tournament. 

SPIVA criticism

It probably hasn’t escaped your attention that the SPIVA research is undertaken by S&P Dow Jones Indices. 

And S&PDJI earns a large slice of revenue by licensing indices to index tracker firms. 

So of course, it’s in S&P’s interest to demonstrate that active funds are falling short. 

But does that mean the SPIVA study is corrupt? 

No, it’s highly respected within the investment industry and attracts remarkably little criticism. 

One of the reasons the study has survived since 2002 is because S&P has updated its SPIVA methodology and addressed some of its biases. 

There’s an interesting discussion of SPIVA’s potential flaws in the paper Uncovering Investment Management Performance Using SPIVA Data by Shah, Wanovits, and Hatfield. 

While the paper’s authors refine SPIVA’s methodology, they concede it’s directionally correct, concluding:

Regarding the passive active debate, we find that passive funds generally outperform active funds in the long run, any advantages of active funds are wiped out by the fees. Only under a bear market does active funds demonstrate an advantage. It does bring into question the value that active fund management brings to investors. 

If you’re relatively new to investing and would like to know more about the active vs passive debate then start by learning:

Why fees matter so much.Why active funds trail index trackers as a group.Evidence from other sources against trying to pick winners. For more on passive investing.

The paradox of skill

Active fund managers are not frauds. They are exceptionally talented and hardworking as a group.

Yet most of them do not beat the market consistently after deducting their fees.

The odds – and the competition from all the other exceptionally talented and hardworking managers – are stacked against them.

But why is outperformance so elusive even for the odd winning fund? Professor Jonathan Berk from the Stanford School of Business says:

If investors find a manager who can consistently beat the market, they will flock to invest with this manager. Eventually, the manager will have so much money under management he will not be able to deliver superior performance. Competition between investors drives the managers return down to the return investors could earn by themselves.

A hot manager becomes such a cash magnet that they have too much money to invest.

Their prior success was based on picking a combination of assets that was overlooked by the competition. But the torrent of new money erodes their uniqueness.

Their portfolio ends up looking like everyone else’s. Mediocre performance follows.

The manager falls down the league table and investors redirect their capital to the next shooting star.

Warren Buffett puts the challenge of picking winners more succinctly:

The problem simply is that the great majority of managers who attempt to over-perform will fail. The probability is also very high that the person soliciting your funds will not be the exception who does well.

Low-cost index funds solve the problem. 

Take it steady,

The Accumulator

The slightly higher propensity of UK active funds to beat the market may mostly be because they hold more smaller cap shares than the index, which is dominated by a handful of giant firms like AstraZeneca, HSBC, Unilever, and Shell – The Investor.

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The SPIVA study provides critical evidence in the case against active management.
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