Active fund managers underperform once again: S&P

And their results don't get any better over the long term

Apr 12, 2017 @ 6:18 pm

By John Waggoner

Legendary Mets manager Casey Stengel once cried out, "Can't anyone here play this game?" Had he asked that about active fund managers, Standard & Poor's would once again reply, "No."

S&P's semi-annual scorecard for active fund managers found them down about 50-1 in the middle of the 2016 playing season. During the one-year period ended June 30, 84.6% of large-cap managers, 87.9% of mid-cap managers and 88.8% of small-cap managers underperformed the S&P 500, the S&P MidCap 400 and the S&P SmallCap 600, respectively.

The batting averages don't get any better over the long term. Over the 10-year investment horizon, 85.4% of large-cap managers, 91.3% of mid-cap managers and 90.8% of small-cap managers failed to outperform on a relative basis, S&P said.

Such miserable performance explains why passively managed funds have fared so well — and why a large number of funds get shuffled off to Palookaville. In the past five years, 21% of domestic and international stock funds were either merged or liquidated. For fixed-income funds, the strikeout rate was 14%.

Extremely good hitters in baseball strike out two-thirds of the time. By that measure, large-cap value funds seem to have some extremely good stock pickers. According to S&P, 67.8% of all large-cap value funds failed to beat their index over a decade. That was the best record among domestic stock pickers. The worst: Mid-cap growth funds, which lost to their benchmarks 95.2% of the time.

International funds fared better than their domestic competitors, but still largely whiffed. Global funds lost to their benchmark 75.3% of the time for the past 12 months, and 81.2% of the time for the past 10 years. Best record: International small-cap funds, which lost to their benchmark 62.3% of the time the past decade.

In theory, smaller, less-followed markets should be easier to beat. And this was true for emerging markets managers the 12 months ended June 2016: The benchmark beat them 42.2% of the time. But that advantage evaporated over time: The benchmark won 81.9% of the time over 10 years.

Many bond fund managers would have been better off on the bench. Long-term investment-grade bond funds got walloped by their benchmarks 98.2% of the time over the past 10 years. Intermediate-term investment-grade managers fared best, losing to their benchmarks 59.8% of the time.

S&P makes a number of adjustments to its scoreboard to make apples-to-apples comparisons. It eliminates the records of merged and liquidated funds, for example, and weights funds' records by assets — so a $50 billion fund isn't scored the same as a $10 million one.

Steve Deschenes, product management and analytics director at Capital Group, says that you can cut down on your risk of bad managers by screening on two factors: Fees and investment management in the fund. "It doesn't matter what the percentage of managers who beat the index is, it matters whether you can identify those who do," Mr. Deschenes said. (Capital Group is the investment adviser for the actively managed American Funds).

If you focus on the least-expensive 20% of funds, you can double the number of successful funds in your screen, he says. After all, it's hard enough to beat the S&P 500, much less by adding on a 1.5% management fee. And fund managers who have $1 million or more invested in the fund tend to have a greater incentive to outperform. "These are relatively intuitive screens," Mr. Deschenes said. "If you look at a cross-section of the least expensive funds and those with high manager ownership, they have dominated in every time period," Mr. Deschenes. Not surprisingly, the American funds score well on both counts, although the funds also have excellent long-term records.

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