It’s been easy to make money in the U.S. stock market over the past several years, which by one accounting stands as the longest bull market in history. However, the best way to make money has also been the simplest: going with the flow.
Since the financial crisis, the dominant strategy for investing in equities has been to favor passive-based strategies, or funds that match the performance of an overall market by holding its same components inn its same proportion. This is in contrast to actively managed funds, where the holdings are selected at the discretion of a portfolio manager, who attempt to do better than the market through individual security selection.
Active management had been standard on Wall Street for decades, and it was tremendously popular in the dot-com era, when high-flying internet stocks minted a number of star managers. In the current expansion, however, the old order has been upended. Some of the least-exciting investments have proved to be the most popular, resulting in a tidal wave of money for passive giant Vanguard.
While the current bull market has featured a number of high-profile advancers — notably large-capitalization technology and internet stocks, which one analysts dubbed the “greatest investment story ever told” — the gains have been widespread, and the S&P 500 SPX, +0.77% has seen prices rise by a factor of four since the bottom of the financial crisis in 2009.
Passive investing has been around for decades, but its adoption accelerated after the financial crisis, as investors sought out cheaper investment options and followed studies that repeatedly showed how few actively managed products do better than the overall market over time.
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According to data from S&P Dow Jones Indices, a huge majority of actively managed equity funds fail to outperform their benchmarks on 5-year, 10-year, and 15-year time frames. This holds for every category of fund (including large-capitalization stocks, mid-caps, and small-caps), as well as for the primary investment styles (core, value, and growth). There are even some categories and time horizons where fully 100% of active funds fail to beat their benchmark.
In the case of funds focused on large-cap equities — funds that would be compared against the S&P 500 — fully 96.76% of the funds did worse than the benchmark over a five-year period, as of data through the end of 2017. That’s on a net-of-fees basis. On a gross-of-fees basis, 88.34% of funds fail to beat the S&P.
Over a 10-year period, the S&P beats 90.66% of active funds on a net-of-fees basis, while it does better than 95.03% on a 15-year time horizon. Gross of fees, the S&P does better than 75.08% of actively managed funds over a 10-year stretch, and better than 83.52% over the past 15 years.
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This trend has extended into 2018, confounding calls for a return to a “stock-picker’s market.” According to data from Goldman Sachs, just 44% of large-cap mutual funds have outperformed the S&P 500 thus far this year, meaning investors would have had better-than-even odds of doing better in a passive fund rather than with a portfolio manager trying to do better than the overall market. Goldman noted that actively managed funds “typically lag in rising equity markets due to the drag from cash holdings.”
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The results aren’t any better for hedge funds. Per the investment bank’s data, the average equity-based hedge fund is up just 1% thus far this year, well below the 7.5% gain of the S&P 500, which closed at a record on Monday. The underperformance was “driven by low net leverage in a rising equity market, outperformance of shorts, and high conviction in favorite positions that underperformed recently,” Goldman wrote.
Facebook Inc. FB, +1.61% in particular has been a drag on hedge-fund performance. The social-media giant is a favorite of hedge funds, but it has tumbled in recent months following a disappointing quarterly report.
The performance issue, along with the significantly lower fees of passive products compared with actively managed rivals, has resulted in an investor exodus from active to passive over the past decade. Hundreds of billions of dollars have been pulled from active products over the past decade, while a similar amount has gone into index products. Exchange-traded funds, an investment vehicle dominated by passive strategies, have been particularly beneficiaries.
Courtesy Goldman Sachs
