S&P: Passive Management Continues to Outperform Active Management

This isn't surprising, but it's important (emphasis added in bold):

Passively managed funds outperformed actively managed funds across all categories during the past five years according to [research from] Standard & Poor's Index Services, which was released today.

Between 2004 and 2008, the S&P 500 stock index outperformed 71.09% of actively managed large-cap funds, according to the year-end 2008 report from the New York-based research firm.

In addition, the S&P MidCap 400 Index outperformed 75.9% of mid-cap funds and the S&P SmallCap 600 Index outperformed 85.5% of small-cap funds.

"The belief that bear markets strongly favor active management is a myth," Srikant Dash, global head of research and design at Standard & Poor's, said in a statement. "The bear market of 2000 to 2002 showed similar outcomes."

Similar results were also reported for international-equity and fixed-income funds.

Among international-equity funds, the indexes outperformed a majority of actively managed non-U.S. equity funds.

For fixed income, the relative shortfall from the five-year benchmark ranged between 2% and 3% a year for municipal bond funds and 1% to 5% a year for investment grade bond funds, Standard & Poor's reported.

Here's a link to the S&P report itself. Especially impressive is the way S&P corrects for survivorship bias:

The Standard & Poor's Index Versus Active (SPIVA) methodology is designed to provide an accurate and objective apples-to-apples comparison of funds' performance versus their appropriate style indices, correcting for factors that have skewed results in previous index-versus-active analyses in the industry. SPIVA scorecards show both asset-weighted and equal-weighted averages, include survivorship bias correction to account for funds that may have merged or been liquidated during the period under study, and show style consistency for each style group across different time horizons.

As we've written over and over, some active funds do outperform the averages in given periods. (By definition!) The trick is to hire those funds before they win...and fire 'em before they lose. After all, hiring them after they've gone winning streaks raises the near-inevitable problem of mean reversion. And hiring them after they've gone on losing streaks isn't especially smart either, because the data show that under-performance is substantially more persistent than out-performance.

So what's the intelligent investor left to do? Favor passive over active vehicles, and ensure that any active vehicles are different enough from their passive counterparts to have a real shot at delivering positive alpha.

Source

Sue Asci, "S&P passive funds trumped active over past five years," Investment News, April 20, 2009

Comments

[donzelion:]

I like a core'n'explore strategy: 90% passive instruments, 10% specific equities. For any developed market, market cap indexes make sense, but emerging markets are hyper-bubble prone and info poor, so I'd stick with dividend weighted indexes for long-term holdings (DEM rather than VWO or EEM).

I tend to give the "explore" portion of the portfolio the most attention, mainly so I can learn things that help in my day job.

Apr 21 04:22 PM

[cmisoptions:]

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"managed500index.com". We are the sub advisors. We off set market declines by 32% since inception and nearly 50% out performance over the last three years. Always hedged! these are all net returns. This is a beautiful offering for the retirement world.

Apr 22 08:53 AM