Yet Another Bad Year for Active Management

Yet another bad year for active managementIt’s not a very good time to be an active manager. Standard and Poor’s just released their mid-year 2015 SPIVA (S&P Indices Versus Active) scorecard, and it tells the story we knew it would – active management doesn’t work. More specifically, active management provides no value.

It’s impossible to predict what the market will do going forward, as all available information is already priced in. Before costs, we should expect active managers to beat their benchmarks half of the time and lose half of the time. Notice I said before costs. After costs, we would expect to see active managers lose more often than they win – especially in the long term.

The new SPIVA scorecard shows exactly that. As of June 30, 2015, almost 2/3 (63.57%) of US equity funds lost to the market over the preceding 12 months. It gets worse through time. Just over 75% of domestic equity funds lost to the market over the last 10 years. In other words, only one out of four funds were able to beat the market over the last 10 years.

Let’s take a look at each asset class:

Now is a Bad Time to Be an Active Manager

As you can see from the table, it’s pretty ugly, so let’s pick out a notable example. Proponents of active management often say active management shines when you get into less liquid areas of the market, which tend to be harder to trade in and more poorly researched.

Take a look at the domestic equity category where active managers fared the best over the past year – large cap growth. First, this is the exact opposite of the illiquid, thinly researched areas of the market. When you think of large cap growth, think of Apple – it’s comprised of the biggest, hottest companies. These are some of the most liquid and heavily scrutinized stocks out there. Active managers did the best in this area over the past year. Let’s get a little context.

Large cap growth funds beat the benchmark 56% of the time over the past year. That’s pretty good, but that kind of performance can be expected considering that active management performance relative to the benchmark is basically random. If we look at a longer time period, we see the same results (actually worse results for active managers) as the total market.

Over the 10-year period ending June 30, 2015, 89.71% of large cap growth funds lost to the benchmark. We see this story consistently – across market sectors, throughout world markets, in bonds – everywhere. While active managers may get lucky in the short term, they are not able to consistently beat their benchmarks. The longer you track their performance, the worse they do.

There is no way to predict what the market is going to do. So while these active managers are out there trying to beat each other, they’re pretty much guaranteeing their own failure. They are constantly fighting to see who can analyze and react to information more quickly, or more intelligently, or whatever they claim to be able to do. So basically every time they make a move, that information is being priced in almost instantly.

Unless someone out there is just systematically better than everyone else – and there is no evidence for that – then how an active manager does relative to their benchmark is just noise. And unlike an active manager’s performance in the market, this noise isn’t random – they are playing a negative-sum game because of the fees they charge you. In other words, active management can’t help you beat the market. You’re better off working toward your financial goals by building a well-diversified, efficient portfolio with low cost funds.

 

McLean Asset Management Corporation (MAMC) is a SEC registered investment adviser. The content of this publication reflects the views of McLean Asset Management Corporation (MAMC) and sources deemed by MAMC to be reliable. There are many different interpretations of investment statistics and many different ideas about how to best use them. Past performance is not indicative of future performance. The information provided is for educational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy or sell securities. There are no warranties, expressed or implied, as to accuracy, completeness, or results obtained from any information on this presentation. Indexes are not available for direct investment. All investments involve risk.

The information throughout this presentation, whether stock quotes, charts, articles, or any other statements regarding market or other financial information, is obtained from sources which we, and our suppliers believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Neither our information providers nor we shall be liable for any errors or inaccuracies, regardless of cause, or the lack of timeliness of, or for any delay or interruption in the transmission there of to the user. MAMC only transacts business in states where it is properly registered, or excluded or exempted from registration requirements. It does not provide tax, legal, or accounting advice. The information contained in this presentation does not take into account your particular investment objectives, financial situation, or needs, and you should, in considering this material, discuss your individual circumstances with professionals in those areas before making any decisions.