BAM Intelligence

Active Even Fails Institutions

Vanguard founder John Bogle’s “cost matters hypothesis” explains why, after subtracting fees, returns from active management tend to be smaller than returns from passive management, as the latter costs less. However, retail investors tend to pay higher advisory and management fees than institutional investors.

Since 2002, S&P Dow Jones Indices has been publishing its S&P Indices Versus Active (SPIVA) U.S. Scorecard. The scorecard measures the performance of actively managed equity funds investing in domestic and international stocks, as well as active fixed-income funds, against their respective benchmarks.

SPIVA Weighs In

For the first time, the 2016 SPIVA Institutional Scorecard examined the impact of fees on the performance of mutual funds and institutional managed accounts against their appropriate benchmarks. The report, which analyzes actively managed funds across equity and fixed-income categories using gross- and net-of-fees returns, covered the 10-year period ending in 2016.

Following is a summary of its key findings:

  • While institutional funds produced better results than mutual funds did, across all asset classes within the domestic equity space, the overwhelming majority of active managers—both retail and institutional—lagged their respective benchmarks. On a net-of-fee basis, the percentage of institutional funds underperforming their benchmark ranged from 63% (large value) to 96% (small growth). The degree of underperformance among small growth funds creates a problem for those who claim the market in small stocks is inefficient and thus ripe for active managers. For mutual funds, the percentage of active funds that underperformed ranged from 64% (large value) to 98% (midcap and small growth).
  • 81% of actively managed international institutional funds failed to provide value after accounting for fees. And 84% of active mutual funds failed to do so. Performance was somewhat better in international small stocks, where “only” about two-thirds of institutional and mutual fund managers underperformed.
  • 79% of active institutional managers investing in emerging market equities, which traditionally has been thought to be one area where active management can add value, fell short of the benchmark after fees. Mutual funds fared even worse, with 86% underperforming.
  • The results in bond markets were not encouraging. In the 13 bond categories examined, the percentage of mutual funds that underperformed ranged from 59% (investment-grade bonds) to as high as 97% (high-yield bonds). The results were similar for institutional managers, though in one category a small majority of active funds outperformed. That occurred in investment-grade bonds, where only 48% of active institutional funds underperformed. This could be explained by active funds having taken more credit or duration risk than the benchmark. On the other hand, 100% of high-yield institutional managers underperformed, and in the supposedly inefficient asset class of emerging market bonds, 75% underperformed.

Supporting Evidence

The findings from the SPIVA scorecard are consistent with those of Joseph Gerakos, Juhani Linnainmaa and Adair Morse in their December 2016 study, “Asset Managers: Institutional Performance and Smart Betas.” They studied the performance of delegated institutional asset managers with $18 trillion in annual average assets under management over the period 2000 through 2012—close to 30% of worldwide investable assets.

They found that on a risk-adjusted basis (accounting for exposure to common factors), the net excess return of institutional managers in U.S. equities was -1.16% with a t-stat of 2.60. For global equities, institutional managers’ net excess return was -1.69% with a t-stat of 2.29. However, the authors also found that the net alphas were positive for U.S. fixed income (0.17%) and global fixed income (0.58%), although statistically insignificant at even the 10% level in both cases (with t-stats of 0.45 and 0.91, respectively).

Even with the advantage of asset management consultants (the majority of institutional investors engage consultants such as Russell, SEI and Goldman Sachs) and the added benefit of incurring lower fees than retail investors, institutional investors failed to outperform appropriate risk-adjusted benchmarks. Additionally, the implementation costs of passive strategies such as index funds, ETFs and types of structured portfolios, continue to fall, creating even greater hurdles for active management.

As Yogi Berra would say, reading the annual SPIVA scorecards is like deja vu all over again. They also explain why the trend toward passive investing and away from active investing is so strong. There is one thing stronger than all the marketing machines of Wall Street and, to paraphrase author Victor Hugo, that is an idea whose time has come. The bottom line is that whether you’re an institutional or a retail investor, active management is the loser’s game.

This commentary originally appeared August 11 on ETF.com

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2017, The BAM ALLIANCE


Larry Swedroe, Director of Research

Director of Research

Larry Swedroe is director of research for the BAM ALLIANCE.

Previously, Larry was vice chairman of Prudential Home Mortgage. Larry holds an MBA in finance and investment from NYU, and a bachelor’s degree in finance from Baruch College.

To help inform investors about the evidence-based investing approach, he was among the first authors to publish a book that explained evidence-based investing in layman’s terms — The Only Guide to a Winning Investment Strategy You’ll Ever Need. He has authored six more books:

What Wall Street Doesn’t Want You to Know (2001)
Rational Investing in Irrational Times (2002)
The Successful Investor Today (2003)
Wise Investing Made Simple (2007)
Wise Investing Made Simpler (2010)
The Quest for Alpha (2011)

He also co-authored four books: The Only Guide to a Winning Bond Strategy You’ll Ever Need (2006), The Only Guide to Alternative Investments You’ll Ever Need (2008), The Only Guide You’ll Ever Need for the Right Financial Plan (2010) and Investment Mistakes Even Smart Investors Make and How to Avoid Them (2012). Larry also writes blogs for MutualFunds.com and Index Investor Corner on ETF.com.

Industry Events

No events scheduled at this time.