Don’t actively managed funds provide greater protection in down markets?

Answer: There is no consistent evidence to support the notion that active management provides outperformance or greater downside protection in down markets; in fact, the evidence points in the opposite direction. To support this notion, we look back on the 2008 SPIVA® Report. The 2008 Report tracks performance after the worst bear market of our lives. When analyzing the data in this report you will find that the results of active management in 2008 were comparable to every other phase of the market cycle – poor. Given hindsight is 20/20, we now know the very small sub- set of “winners” were random and unpredictable, with many who succeeded in 2008, since subsiding into mediocrity or ceasing to exist today.

Aren’t actively managed funds more effective at providing superior returns in inefficient markets?

Answer: An efficient market is one in which there are a sufficient number of willing buyers and willing sellers exchanging goods. Thus, an efficient market accurately set prices based on all available sources of information. A common theme that is portrayed by active managers is their ability to outperform a given benchmark in emerging markets, because active managers claim emerging markets are “inefficient” and that informational inefficiencies can be exploited within stock selection and market timing. The data contained in 2023 SPIVA Scorecard, “Report 6: Percentage of International Equity Funds Outperformed by Benchmarks” (pg.21) illustrates this to be a myth – over the trailing 20-year period, over 95% of emerging market funds have underperformed their benchmark. In other words, active managers in emerging markets equities have demonstrated little ability to outperform the market that goes beyond randomness and luck.

Can’t some of the really good managers outperform on a consistent basis (persistency)?

Answer: According to the S&P persistence scorecard relatively few funds can consistently stay as top performers in their respective asset class. Of the relatively few funds that outperform, few can do so repeatedly. Across all funds, the incidence of 3 years or 5 years of consecutive top half performance is generally less than that expected by random chance. There is little evidence that managers who have outperformed can predictably continue to outperform. If managers cannot consistently outperform, then there is no use trying to identify them in advance. Manager selection and the hiring or firing of managers is a futile exercise. The question then becomes how do we know which funds will outperform in any given year? The answer is, we don’t know. Even if we did, based on the data, it is not very probable that the same fund will consistently be a top performer. Thus, there will likely be adverse tax consequences and load fees from changing funds year to year.

Active vs. Passive - Passive Capital Management

Active vs. Passive – Passive Capital Management

As steadfast passive investment advisors we are often confronted with many questions surrounding the ever present active vs. passive debate. While we know and expect that the available data and evidence strongly support a passive investment philosophy, it may not always be as apparent to the everyday investor. Knowing this, we thought that it would be a helpful exercise to cover some of the more frequently asked questions surrounding this debate and provide real data to support our position.

The Data –

Every year S&P Global publishes the annual SPIVA® (S&P Indices Vs. Active) U.S. Scorecard which evaluates whether actively managed funds are able to outperform their corresponding indices over different periods of time (1,3,5,10 & 20-years). Corresponding indices are a hypothetical portfolio of investment holdings which represents a segment of the market and index funds are close approximations of these indices. The key takeaway from the most recent report is no different than that of years past and that is the majority of domestic actively managed funds have underperformed their respective indices over long periods of time. In one (1) year periods you will find that a small number of active managers (25% of domestic equity funds outperformed for 2023) will be able to beat their respective benchmarks, however the likelihood of those same managers producing consistent results is very small. Over the 5-, 10- and 20-year time periods we see the number of outperforming domestic fund managers reduce significantly to 15%, 9% and 7% respectively (far less than a coin flip!).

Similarly, Morningstar® releases a semiannual report, Morningstar’s ® Active/Passive Barometer, that measures the net-of- fees performance of U.S. active funds against their passive peers. What makes this study different is that Morningstar® compared active funds against comparable passive funds (with expenses), not benchmark indices. The most recent study covered about 8,326 unique funds in total and spans over a 10-year period. This study found that while 51% of active domestic funds outperformed their passive peers for the trailing year (ended June 2024), over the past 10-years, just 24% of all active funds beat their passive peers.

The S&P Persistence Scorecard, which is released semiannually, tracks the consistency of which active mutual fund managers outperform over consecutive 12-month periods. The Persistence Scorecard uses the University of Chicago’s CRSP Survivorship Bias Free Mutual Fund Database to rank available funds in the top-quartile and top-half in performance over non-overlapping three- and five-year periods. The Persistence Scorecard also tracks the amount of funds that are liquidated or consolidated in any 12-month period. The report illustrates that no one can accurately predict which actively managed funds will outperform each year, let alone which managers will outperform or even survive over long periods of time.

In conclusion, all three (3) studies provide strong evidence that the probability of active managers consistently earning excess returns is extremely low. To answer the below FAQs, we will use these empirically robust third-party research reports as our basis to measure the success of active vs. passive investment philosophies.

Frequently Asked Questions

Don’t actively managed funds provide greater protection in down markets?
Answer: There is no consistent evidence to support the notion that active management provides outperformance or greater downside protection in down markets; in fact, the evidence points in the opposite direction. To support this notion, we look back on the 2008 SPIVA® Report. The 2008 Report tracks performance after the worst bear market of our lives. When analyzing the data in this report you will find that the results of active management in 2008 were comparable to every other phase of the market cycle – poor. Given hindsight is 20/20, we now know the very small sub- set of “winners” were random and unpredictable, with many who succeeded in 2008, since subsiding into mediocrity or ceasing to exist today.
Aren’t actively managed funds more effective at providing superior returns in inefficient markets?
Answer: An efficient market is one in which there are a sufficient number of willing buyers and willing sellers exchanging goods. Thus, an efficient market accurately set prices based on all available sources of information. A common theme that is portrayed by active managers is their ability to outperform a given benchmark in emerging markets, because active managers claim emerging markets are “inefficient” and that informational inefficiencies can be exploited within stock selection and market timing. The data contained in 2023 SPIVA Scorecard, “Report 6: Percentage of International Equity Funds Outperformed by Benchmarks” (pg.21) illustrates this to be a myth – over the trailing 20-year period, over 95% of emerging market funds have underperformed their benchmark. In other words, active managers in emerging markets equities have demonstrated little ability to outperform the market that goes beyond randomness and luck.
Can’t some of the really good managers outperform on a consistent basis (persistency)?
Answer: According to the S&P persistence scorecard relatively few funds can consistently stay as top performers in their respective asset class. Of the relatively few funds that outperform, few can do so repeatedly. Across all funds, the incidence of 3 years or 5 years of consecutive top half performance is generally less than that expected by random chance. There is little evidence that managers who have outperformed can predictably continue to outperform. If managers cannot consistently outperform, then there is no use trying to identify them in advance. Manager selection and the hiring or firing of managers is a futile exercise. The question then becomes how do we know which funds will outperform in any given year? The answer is, we don’t know. Even if we did, based on the data, it is not very probable that the same fund will consistently be a top performer. Thus, there will likely be adverse tax consequences and load fees from changing funds year to year.

PCM believes investors should decide on an asset allocation appropriate for their risk tolerance, accept the long-term positive returns that the market provides, stay disciplined throughout all the cycles (ups and downs) of the market and save more of your money for yourself instead of spending it on fund expenses and taxes.

This material presented by PCM is for informational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy, or investment product. Facts presented have been obtained from sources believed to be reliable, however PCM cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. PCM does not provide legal or tax advice, and nothing contained in these materials should be taken as legal or tax advice. Advisory services are only offered to clients or prospective clients where PCM and its representatives are properly licensed or exempt from licensure. No advice may be rendered by PCM unless a client service agreement is in place. SEC registration does not constitute an endorsement of the firm by the Commission, nor does it indicate that the adviser has attained a particular level of skill or ability.

Active vs. Passive – Passive Capital Management

Author: Passive Capital Management Team