This year is the year that active management will outperform. This is true, because every year is the year that active management will outperform. Yet the latest data show that most pros can't beat the market. Sam Ro summed it up perfectly, which I'll share with you today.
According to the latest S&P Dow Jones Indices (SPDJI) 51.2% of U.S. large-cap equity fund managers underperformed the S&P 500 during the first half of 2022 — despite the fact that the S&P itself fell into a bear market during that period.
The chart below shows us the percentage of Large-Cap US equity funds underperforming the S&P500 each year.
"Market downturns typically offer abundant hunting grounds for active managers...while actively managed large-cap U.S. equity funds were on track for their best (i.e., lowest) underperformance rate since 2009, still less than half were able to outperform their benchmark in the first six months of 2022, echoing a prevailing SPIVA theme: The majority of actively managed funds are unable to outperform their benchmarks over the long-term, said Tim Edwards, Managing Director SPDJI. Funds did however, improve from last year's 85.1% underperformance for what its worth.
If your money manager was one of the lucky ones to generate returns greater than that of the market, you better hope its more than just luck that got them across the line.
According to the SPDJI report, of the 29% of 791 large-cap equity funds that beat the S&P 500 in 2019, 75% beat the benchmark again in 2020. But only 9.1%, or 21 funds, were able to extend that streak of outperformance into 2021, as can be seen in the chart below along with several other asset class segments.
I guess they're not kidding when they say “Past performance is no guarantee of future results.”
If you're wondering why it's so damn hard to pick the winners that will see your portfolio glow in the limelight, well, it's because the odds aren't in your favour. The research shows us that only 22% of the stocks in the S&P 500 outperformed the index itself from 2000 to 2020.
Over that measurement period, the S&P 500 gained 322%, while the median stock rose by just 63%.
It’s also worth noting that if you had a portfolio of stocks consisting of mostly underperformers and a few outperformers, this wouldn’t necessarily mean you’d be underperforming the index.
“This is because stock market returns tend to be positively skewed,” Craig Lazzara, managing director at SPDJI, wrote in that 2021 report. “Rather than being symmetrically distributed around an average, return distributions typically have a very long right tail; a relatively small number of excellent performers has a disproportionate influence on the market’s overall return.”
In other words, if your outperformers are way out on the right tail of the above chart, then they might be generating massive returns that more than offset all of the underperformance of the other stocks. Unfortunately, no one has a great track record at identifying the stocks that’ll become these “excellent performers.”
Taken together, everything you’ve read above makes a very strong case for passive investing, which can be pretty boring. But in this particular context, boring can be sexy.
Barry Ritholtz, cofounder and CIO of Ritholtz Wealth Management, explained in a recent blog post:
5. Consistent average returns turn into above-average returns over time. Howard Marks has discussed why typical managers who finish in the top 10% in any given year underperform over the long haul. They tend to be narrow and specific, and their sector/style/region goes in and out of favor. Bouncing between the top and bottom deciles is not a formula for long-term performance. Instead, consistently achieving a modest target in the middle will eventually turn in top quartile returns (or better).
This is a brilliant way of thinking about all of these SPDJI studies. If only 9.1% of large-cap equity fund managers beat the S&P 500 from 2019 to 2021, then being in an S&P 500 index fund means you would’ve beat 91% of the pros during the period.
My co-host, Matt Rigby and I, chat about markets in last week episode of The Wide Lens podcast.
You can also listen to the podcast on Spotify or wherever else you listen to your podcasts.