S&P Dow Jones scores dismal results for active stock management

Last year was a particularly dismal year for U.S. stock managers, providing more evidence for a long-term trend of underperformance. In 2014 over 87 percent of all U.S. stock funds underperformed their respective benchmarks.

Since 2003 SPIVA has been the de facto scorekeeper of performance by actively managed funds against their relevant market benchmarks. Their semi-annual SPIVA report ("S&P Indices versus Active") measures fund returns against the returns of a benchmark appropriate for that particular investment category. Large-cap funds, for example, are measured against the S&P 500 Index; U.S. stock funds collectively are measured against the S&P Composite 1500.

In 2014, a majority of actively managed stock funds underperformed across every category: 87 percent of U.S. stock funds and 69 percent of international stock funds underperformed.

Although 2014 was a particularly brutal year for active managers, we know that results can vary significantly from year-to-year. In 2000, for example, only 40 percent of all U.S. stock funds underperformed, meaning that most of them did quite well. Over any 12-month period the results of active management versus the indices will be mixed.

The most recent report, however, adds to the steady accumulation of data showing the improbability of active stock management succeeding over the long-term. Not the impossibility, but the improbability.

Over the past 10 years only about 1 in 4 active U.S. stock managers outperformed their appropriate market benchmark.

Two other trends reported by S&P Dow Jones shed further light on the poor showing by active management overall and the challenge faced by investors trying to identify the winners in advance.

First, funds disappear at a startling rate. Over the past five years, according to the 2014 SPIVA report, "nearly 24 percent of domestic equity funds, 24 percent of global and international equity funds, and 17 percent of fixed income funds have been merged or liquidated."

The survival rate over 10 years is worse yet. Only 58 percent of US stock funds and 60 percent of international stock funds in existence in 2005 were still around by the close of 2014. It's tough to pick a winner when 4 out of 10 funds won't even make it to the finish line.

Second, a large percentage of funds engage in "style drift." Style drift measures the percentage of funds that have the same style classification at the end of the time period as at the beginning of the time period.

Measuring style drift is important because the tendency of a fund to drift or diverge from its initial investment category can upset an investor's asset allocation plan. About 90 percent of an investor's investment performance can be explained by how the investments are allocated across asset classes.

An investor does not want to invest in a small-cap value stock fund, for example, only to find out after the fact that it was really a mid-cap growth fund.

Over the past 10 years, fund managers has shown relatively low style consistency. Only 34 percent of all U.S. stock funds had the same style classification at the end of 2014 as they had at the start of 2005.

In all categories, except one, the percentage of funds that had the same style classification at the end of 10 years was well under 50 percent, ranging from 27 percent to 46 percent. The exception was real estate where at the end of 10 years just over 70 percent of the funds still were still real estate funds.

Now, one would think that a real estate manager would have a clear understanding of his or her investment mandate. The fact that 29 percent of real estate funds ended up being something else over the course of 10 years should be troubling to investors.

And the same story is repeated with international stock funds. Over a 10-year period only 58 percent remained true to their original classification. That means that 42 percent became something other than an international stock fund. Most of them probably became some version of a "go anywhere" global fund.

The allure of active management will always be the possibility it offers to "beat the market," to do better than its market benchmark. Investors' expectations, however, will be better grounded in probabilities rather than possibilities.

The SPIVA report tells us that the more probable path to investment success will be to capture market-like returns at an efficient cost using index or market tracking funds.


David Peartree, JD, CFP® is the principal of Worth Considering Inc., a registered investment advisor offering fee-only investment and financial advice to individuals and families. Offices are located at 160 Linden Oaks, Rochester, NY 14625; email david@worthconsidering.com.

Published: Mon, Mar 23, 2015