The reports of active management’s rebirth may have been greatly exaggerated.
Despite some signs that stock pickers were seeing better performance than the overall market earlier this year, more recent data has pointed to a continuing struggle to outperform, in what could be another tailwind to passive investing.
Passive investing is when investors buy a fund that mimics the performance of an index like the S&P 500 SPX, +0.49% ; the fund will own the same securities as the underlying index, and in the same proportion. This is in contrast to active management, where the holdings of a portfolio are selected at the discretion of a manager.
Data have repeatedly shown that passive funds are far more likely to deliver better long-term performance than their active equivalents, even before the much-higher fees of active products are taken into account.
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, midcaps, 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.
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The percentage of active managers that outperform their benchmark is a volatile metric, but recent data had indicated a better environment for the strategy. According to May data from Goldman Sachs, 56% of large-cap mutual funds were outperforming their benchmark, putting them on track for their best year of relative performance since 2007.
Some hailed that performance as representing a renaissance for active management — which has seen an exodus of investor money amid a shift to passive funds — but the “stock picker’s market” seems to have evaporated. According to new data from JPMorgan, just 41% of funds are currently outperforming year-to-date, compared with the 52% that had been outperforming at this point in 2017.
For the category of large-cap core funds, only 27% of managers are topping their index.
“In our view, this fund category has been underperforming due to narrowing stock leadership, fewer opportunities, and a series of market narratives driving style and sector rotations,” the firm wrote to clients, citing Federal Reserve policy and uncertainty surrounding trade as among the narratives driving trading.
It isn’t uncommon for aggregate active performance to fall following periods of strength; according to JPMorgan’s data, it is rare that major categories — including strategies for value or growth — have more than 50% of managers outperform for consecutive quarters.
According to Wells Fargo, there hasn’t been a year when more than 50% of managers outperformed their benchmark since 2009.
Courtesy Wells Fargo
To a certain degree, active-manager performance is somewhat dependent on the investing environment. There have been signs that the strategy of value investing — following a decade of underperformance — is seeing a rebound; thus far this year, 65% of value-based funds are outperforming, compared with just 43% of growth funds.
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Manager skill also plays a role in the performance of a fund. However, the role tends to be negative.
According to the S&P Dow Jones Indices “Persistence Scorecard,” it is extremely rare that top-performing funds can maintain their status of outperformers.
Per the data, which was released on Monday but only covers the period through March 2018, a vanishingly small percentage of funds remain in the top quartile of performers over a two-year period. Of the 557 domestic stock-based funds that were in the top quartile in March 2016, “only 2.33% managed to stay in the top quartile at the end of March 2018,” the report read.” Fewer than 1% of large-capitalization stock funds stayed in the top quartile, while 3.85% of small-cap funds did. Zero midcap funds stayed in the top group over the period.
The results weren’t much better over longer time horizons. Fewer than 22% of large-cap funds stayed in the top half of performers over three consecutive 12-month periods. That represented the best percentage of the asset-class sizes: just 13.46% of small-cap funds stayed in the top half of performers, while 7.59% maintained a top-half ranking.
Courtesy S&P Dow Jones Indices
Beyond the performance data, active funds tend to charge significantly more than their passive equivalents. According to data from Morningstar, actively managed funds carried an average fee of 0.72% in 2017, nearly five times the 0.15% average charged by passive funds.
