It’s a stock picker’s market, right? Investment manager earn their keep during down markets, right? Actively managed mutual funds can take advantage of market dispersion and volatility to pick outperforming stocks, right?
Wrong.
Yet again – through up markets, down markets, calm markets and volatile markets – Standard and Poors (S&P) proves that the myth of active investment management is pure bullshit.
S&P periodically releases the SPIVA Scorecard, which compares the performance of active mutual funds against their benchmarks. Whether looking at Canada, US or UK, this report has repeatedly shown that active managers underperform.
The SPIVA report is probably the most accurate of all mutual fund evaluations because of what it doesn’t leave out. The SPIVA Scorecard accounts for mutual fund survivorship bias. This adjustment is critical to understanding the true extent of manager underperformance over time.
Here’s how S&P explains this important adjustment:
Many funds might be liquidated or merged during a period of
Standard & Poors SPIVA Canada Scorecard
study. However, for a market participant making a decision at the beginning of the period, these funds are part of the opportunity set. Unlike other commonly available comparison reports, SPIVA Canada Scorecards remove this survivorship bias.
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Facts (from the SPIVA Canada Scorecard- ending June 30, 2020):
- 88% of Canadian equity funds underperformed their benchmarks over the past year, in line with the 90% that did so over the past decade
- On an asset-weighted basis, Canadian Equity funds returned a dismal 7.9% below the S&P/TSX Composite over the past year.
- U.S. Equity funds posted the highest returns over the past year, with a 6.7% gain on an equal-weighted basis and 10.8% on an asset-weighted basis. Both of these metrics fell short of the 12.1% gain of the S&P 500 (CAD), with 84% of funds failing to clear this hurdle over the past year.
- U.S. equities offered the best returns over the past decade, with the S&P 500 (CAD) gaining 16.9% per year, but active funds were unable to keep up: 95% fell short, by an average of 4.1% per year on an equal-weighted basis.
- 53% of all funds in the eligible universe 10 years ago have since been liquidated or merged.
The performance tables below compare mutual fund categories (e.g. ‘Canadian Equity’) against their benchmarks (e.g. ‘S&P/TSX Composite’). The first table shows equal weighted returns (average fund return) and the second shows asset weighted returns (average fund returns weighted by size of assets in a fund). As you can see, there is significant underperformance across all time periods and categories.
This is not just an issue with the Canadian mutual funds industry. Here are some facts about the performance of mutual funds sold in the US:
Facts (from the SPIVA US Scorecard- ending June 30, 2020):
- In 11 out of the 18 categories of domestic equity funds, the majority of funds continued to underperform their benchmarks.
- 67% of domestic equity funds lagged the S&P Composite 1500® during the one-year period ending June 30, 2020.
- In 13 out of the 14 fixed income categories, the majority of funds failed to keep up with their benchmarks.
- Fund liquidation numbers across segments regularly reached into the 60% range over a 15-year horizon.
The equal and asset-weighted performance comparisons for US mutual funds are equally bad and just as significant as fund underperformance in Canada.
Why do most mutual funds underperform?
It’s simple.
1) Mutual funds charge a fee that can be as high as 3% in some cases (most are probably closer to 2%). Just to perform in line with the benchmark a fund manager has to outperform by the fee charged. They are starting from behind.
2) Mutual fund managers are trying to outperform against millions of other professional investors, all with the same public information. By the very nature of the market, there will be people who are wrong and people who are right. It is very difficult to be repeatedly right about something impacted by an infinite number of variables. Hence, the chance about being right about a particular portfolio (relative to a benchmark) at any point in time is about 50/50. Those odds are reduced over longer periods of time (the odds of flipping heads once is 50%, the odds of flipping heads twice in a row is 25%).
In that it provides no value added, investment fund management is therefore a commodity. An allocation to diversified portfolio of stocks has value, but the overlay of ‘active investment management’ provides no additional value (actually, it subtracts value as shown above). Investors should not pay for something that isn’t delivered. Therefore, investors should not pay active management fees, which are significantly higher than passive fees. This difference in fees could mean the difference between retiring well or retiring broke.
