Indexology^® Blog

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This is the Sanity test post for unpublished author

We recently issued our mid-year SPIVA^®  reports for the U.S., Australia, and Europe, and other regions will follow in due course.  Although one can sometimes find exceptions in the short run, the long-term results of SPIVA can be easily summarized:

• The majority of active managers underperform most of the time.
• Historical success does not predict future success.

SPIVA continues a line of inquiry that began nearly 90 years ago with the first study of active fund performance versus passive benchmarks.  This work accelerated in the 1970s, as the growth of professional portfolio management drew increasing academic interest.  Nobel laureate Paul Samuelson was representative of his contemporaries in suggesting that “most portfolio decision makers should go out of business.”

Active managers didn’t take kindly to Samuelson’s suggestion in 1974 and, despite the accumulation of confirming evidence since then, they don’t take kindly to it today either.  We’ve estimated that the cumulative cost savings to asset owners just from indexing the S&P 500, S&P MidCap 400, and S&P SmallCap 600 amount to better than $300 billion, and every dollar of costs saved by the investor is a dollar of fees not paid to an active manager.  So while resentment is to be expected, it’s surprising that critics of SPIVA sometimes focus on its minutiae, rather than on its results.

The most important thing to realize about SPIVA results is that they are not a coincidence.  The active management community didn’t lose a cosmic coin flip 90 years ago; active underperformance happens for a set of readily identifiable reasons.  These include:

Professionalization.  Portfolio management is a zero-sum game; the only source of alpha for the winners is the negative alpha of the losers.  When most of the assets in a market are professionally managed, the average professional won’t beat the market because the average professional is the market.  It’s not a coincidence that the first index funds were launched in the 1970s; by that point the U.S. equity market had been largely professionalized.

Cost.  The expense ratio of the average actively-managed equity mutual fund was 0.74% in 2019; the average index fund cost 0.07%.  The average active manager therefore starts out 67 basis points in the hole.

Skewness.  The distribution of stock returns is skewed – i.e., most stocks underperform the market average.  Exhibit 1 illustrates this for the S&P 500.

Exhibit 1.  Most Stocks Underperform the Market Average

Source: S&P Dow Jones Indices LLC, FactSet. Data from Dec. 31, 1998 through Dec. 31, 2019.  Past performance is no guarantee of future results.  Chart is provided for illustrative purposes.

Of the 1010 stocks that were part of the S&P 500 between 2000 and 2019, only 267 returned more than average.  The probability that a randomly-chosen stock would deliver above-average performance, in other words, was 26%, not 50%.  When fewer stocks outperform, active management is harder.

These (and other!) reasons are robust and sustainable.  Investment management will stay professionalized, active costs will always exceed index costs, and in most years most stocks underperform the average in most markets.  The index advantage is likely to persist.

TTest

Now,

every single sector, style and size of

the market are down this month,

which has only ever happened

in 9 other months in history.   While 6 of those months have come in pairs, the Januaries following Decembers of years this bad are slightly positive, up 11 of 20 times, averaging 65 basis points with positive years in 13 of 20 times with an average return of 4.2%.  As discussed in this post, the first few days of a rebound is key for investors, so don’t miss it – and historically, mid-caps and small caps typically do much better in rebounds than large caps.  There are some bright spots as the economy is still growing, the labor market is tight and consumer spending is healthy with contained debt levels.