https://www.columbiatribune.com/news/20190315/annual-report-highlights-active-vs-passive-investing-debateAnnual report highlights active vs. passive investing debate
By Tim Sullivan
Posted Mar 15, 2019 at 2:29 PM Updated Mar 15, 2019 at 2:29 PM
Each year the S&P Global corporation publishes a report highlighting the “active versus passive” debate in its SPIVA U.S. Scorecard. For some background, S&P Global creates, tracks, and publishes many of the market indices through a jointly owned subsidiary, the S&P Dow Jones Indices. Even casual investors are likely familiar with its two most famous indices, the S&P 500 and the Dow Jones Industrial Average. Below are some highlights from the recently released 2018 report.
First, what is the “active versus passive” debate. Essentially, it’s the debate over whether active money managers can beat an appropriate benchmark over a given time period. For example, an actively managed mutual fund that invests in a broad array of large U.S. based companies would likely use the S&P 500 as its benchmark. The job of the manager of that fund is to “beat the market”—basically to provide returns superior to what many would consider “average” returns, meaning the S&P 500.
To further clarify this concept, imagine a large bowl full of lots of different candy. In this case, each candy will represent a company in the S&P 500. An index fund manager will look at the bowl and say, “I’ll take the whole thing please.” In other words, instead of trying to sort through and pick out the best candy, they just take the whole lot. This is not overly difficult and can be done very inexpensively.
On the other hand, an active fund manager will study the candy carefully. They read the ingredients, study the wrapper, feel the size and shape, call the people who made the candy, and generally do anything they can to try to pick out what candy they think will be the best. Unfortunately, they can’t taste the candy so they are limited in what they can ultimately determine. This is a very difficult job and as such, they get to charge customers a tremendous amount of money for the privilege of their expertise.
So how did it go in 2018? Not well if your job was to pick the best candy. In fact, nearly 65% of active managers investing in large-cap companies underperformed the S&P 500. Think it’s unusual that the “pros” can’t outperform their benchmark by even a fraction of a percentage? Think again. This was actually the 9th consecutive year where they underperformed!
Surely the small-cap managers, those guys and gals investing in small companies across the U.S., had better luck investing in an area many consider “inefficient.” Nope, nearly 69% of actively managed small-cap funds lagged their benchmark, the S&P SmallCap 600, in 2018.
Active managers had a few highlights. The outlier was the nearly 85% of mid-cap growth fund managers able to top their respective benchmark, the S&P MidCap 400 Growth. Managers focused on large-cap value funds were also able to outperform in about 54% of their funds versus the S&P 500 Value index.
The real story is how each investment style performs over a longer time period, and the results aren’t much brighter for active managers there either. In fact, across all stock funds of various asset classes and sizes, at least 80% of active managers failed to beat their appropriate benchmark over both the last 10 and 15-year time frame. Almost astoundingly, over the last 15-years just under 89% of all domestic actively managed funds failed to beat their benchmark.
Somehow the “active versus passive” is still a debate despite these overwhelming statistics. Why? Because accepting “average” is not in our DNA. Investors want “superior” returns with “above-average” results and active managers that can produce “alpha.” However, is there another industry anywhere selling a product with an 89% failure rate that still claims so vociferously to outperform lower cost options? Perhaps, but they sure don’t market it as well as the financial industry.
Tim Sullivan is the owner of Clarity Financial LLC, a fee-only advisory firm in Columbia, a CFP practitioner and member of the National Association of Personal Financial Advisors and has earned the Enrolled Agent designation from the IRS.
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