A couple of weeks back, Bloomberg published an article titled “The World's Most Popular Stock Picks Are Sinking.” And from the first line, the conclusion was clear: “A successful strategy to avoid the worst of this year’s equity retreat: ask your analyst what to buy and sell, then do the opposite.”
As we’ve written before, not making investment decisions based on predictions of the future is pretty smart. Avoiding the stock picks of active fund managers is a good strategy too. Most actively managed funds are dependent on clever marketing and not superior investment results. In fact, because of their higher costs (some of them hidden), the majority of actively managed funds actually trail the benchmarks they set out to beat. Worse performance. Higher costs. Not exactly a good trade off.
S&P with their Indices Versus Active (SPIVA®) study does a good job tracking this performance and last week released the Year-End 2015 Scorecard. Here are a few highlights from the report.
- During , 66.11% of large-cap managers, 56.81% of mid-cap managers, and 72.2% of small-cap managers underperformed [their benchmarks].
- The figures are equally unfavorable when viewed over longer-term investment horizons. Over the five-year period, 84.15% of large-cap managers, 76.69% of mid-cap managers, and 90.13% of small-cap managers lagged their respective benchmarks.
- Similarly, over the 10-year investment horizon, 82.14% of large-cap managers, 87.61% of mid-cap managers, and 88.42% of small-cap managers failed to outperform on a relative basis.
- During the same period, the majority of actively managed funds invested in international developed and emerging markets outperformed their respective benchmarks. Over the 10-year investment horizon, however, managers across all international equity categories underperformed their benchmarks.
- The high-yield bond market is often considered to be best accessed via active investing, as passive vehicles have structural constraints that limit their flexibility and ability to deal with credit risk. Nevertheless, the 10-year results for the actively managed high-yield funds category show that over 90% of funds underperformed the broad-based benchmark.
- Funds disappear at a meaningful rate. Over the past five-year period, nearly 23% of domestic equity funds, 22% of global/international equity funds, and 17% of fixed income funds have been merged or liquidated.
And here is a summary of the SPIVA data in chart form.
At this point it should be clear, the majority of actively managed funds don’t deliver value. They instead rely on clever marketing and prey on investor's overconfidence. As Robin Powell recently wrote on his Evidence-Based Investor blog:
“There have been several studies that show how prone investors are to overconfidence. For example, a study called Positive Illusions and Forecasting Errors in Mutual Fund Investment Decisions found that they tend to inflate both their future and past performance. More than a third who believed that they had beaten the market had actually underperformed by at least 5%.
A more recent study by Kent Daniel and David Hirshleifer identified a very strong link between overconfidence on the one hand and excessive trading and lower returns on the other.”