My Name is John, And I Was An Active Fund Manager
Larry Swedroe reminds us, yet again, that “Actively Managed Funds Underperform on a Risk-Adjusted Basis.”
This should not surprise any of my clients, but the general investing public, especially those currently under the care of financial advisors who actively manage their investment portfolios, remains blissfully unaware of this fact. As Larry writes:
"Since 2002, S&P Dow Jones Indices has published its S&P Indices Versus Active (SPIVA) scorecard, which compares the performance of actively managed equity mutual funds to their appropriate index benchmarks. While their SPIVA scorecards persistently demonstrate that large majorities of active funds underperform their benchmarks (even before considering taxes) in absolute returns, they do not address the claim that active funds may be superior to passive investment after adjusting for risk. With that in mind, using standard deviation as the measure of risk, they developed a risk-adjusted scorecard.
Following is a summary of their 2019 report:
Over the last five-, 10- and 15-year periods, 84%, 97% and 92%, respectively, of actively managed large-cap funds underperformed their benchmarks.
Over the last five-, 10- and 15-year periods, 65%, 80% and 86% of actively managed mid-cap funds underperformed their benchmarks.
Over the last five- , 10- and 15-year periods, 77%, 89% and 87% of actively managed small-cap funds underperformed their benchmarks – exposing the myth that active management works in the supposedly inefficient asset class of small-cap stocks.
As in the U.S., the majority of international equity funds across all categories generated lower risk-adjusted returns than their benchmarks. For example, over the five-, 10- and 15-year periods, 75%, 80% and 89% of actively managed emerging market funds underperformed – exposing another myth that active management works in the supposedly inefficient asset class of emerging markets. Similar results were found with international small-cap funds, where 78%, 63% and 68% underperformed.
A large majority of actively managed fixed-income funds in most categories underperformed over all three investment horizons. At the 15-year horizon at least 60% of active funds underperformed in all categories, and in only two of 14 categories fewer than 78% underperformed. The worst performance came in the supposedly inefficient asset class of emerging-market debt, where over 10- and 15-year periods not a single active fund outperformed. Over the five-year period, 98% failed to outperform.
The authors concluded: “We did not see evidence that actively managed funds were better risk-managed than passive indices. Actively managed domestic and international equity funds across almost all categories did not outperform the benchmarks on a risk-adjusted basis.”"
The numbers speak for themselves, so why do so many people still insist that “their guy” is the one who will succeed where so many other have failed? Or, that they can create their own portfolio which will outperform the market? There are a few issues at play here:
One is that many financial advisors are salesmen first, and advisors second. This is totally understandable from two standpoints. The first is that many “advisors” really are just product salesmen, be it insurance, mutual funds, or whatever their firm is looking to sell. And let me tell you, insurance salesmen are some of the best in the business. Heck, they convinced me I could work for a financial advisor owned by an insurance company and still do right by my clients! Oops. The second, less damning, reason is that for financial advisors to make a living, they have to convince potential clients of their worth, and people want to feel like they are getting the “secret sauce.” People want to believe that their advisor will “give” them good returns on their investments, and even, in some cases, “protect” them from market downturns. As a result, it’s much easier to sell someone the idea that an advisor’s skills, or their firm’s practices, will make a client money, than it is to tell them that only the market giveth, and the market taketh away.
Another issue, somewhat related to the second point above, is that people - especially smart people - also want to believe that they can get a leg up on the market through hard work and diligent investment research. Rick Ferri’s almost decade old article, “Why Smart People Fail to Beat the Market” sums it up as well as I’ve ever seen. I fell into this trap myself for years. I believed that since I worked on Wall Street trading desks & was a big time investment banker, my “superior” education, training, and intelligence gave me an advantage. Decades later, I can look back & see that my personal investment decisions did almost nothing but cost me money. Before I threw in the towel on “managing” my personal portfolio, its returns, though positive over time, paled in comparison to the S&P 500.
The only way I know to capture as much of what the market provides is to invest regularly, and keep the costs as low as possible. If someone tries to convince you otherwise, ask them how they get paid.