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SPIVA: the evidence against active funds

SPIVA: the evidence against active funds post image

The chief attraction of active fund management is the prospect that these investing superstars can beat the market for you. Yet one of the most powerful counters levelled against them is that they mostly fail. How do we know they fail? Enter the S&P Indices Versus Active Funds (SPIVA) study that scores active management vs the market.

The SPIVA research reveals two important pieces of evidence:

  • The vast majority of active funds trail the performance of market benchmarks over ten years.
  • The funds that do outperform are unlikely to maintain their hot streak. 

Let’s consider the key SPIVA findings that are relevant to UK investors.

Active funds outperformed by benchmarks over 10 years

SPIVA Europe year-end 2021 results show that the overwhelming majority of active funds do not beat their market benchmarks

Source: S&P. “SPIVA Europe Scorecard Year-end 2021.” 10-year risk-adjusted returns. GBP funds.

The outcome is overwhelming. 

The majority of active funds fail to win (green wedges) against relevant market benchmarks over a reasonable investing timeframe. 

This means of course that most active funds aren’t beating index funds and ETFs, either. Remember: index trackers seek to match their particular market (described by a benchmark) minus costs. 

Active funds cost more. So they’ll trail index trackers if they don’t leave the market choking in their dust. 

Same old story

The SPIVA study was first published in 2002. It has been updated regularly ever since. And the results are damning every year. 

The only rational conclusion? Backing active funds versus the market these days makes about as much sense as putting your money on a chess grandmaster versus an Artificial Intelligence. 

The prestige still enjoyed by active funds is a similar relic of a bygone age. It persists because we love to back a human with a compelling story. 

I suppose the pie charts do reveal a kernel of truth to the claim that active managers can better uncover opportunities in smaller and less efficient markets. 

But even in UK equity, where a substantial minority of funds outperform, the majority do not. 

Sic transit gloria fund-y

But this is all doomster talk surely? Why can’t we just pick today’s winners and ride them to glory?

Never mind that ‘Past performance does not guarantee future results’ old pony plastered around the documents by some gloomster regulator with EU sympathies.

Why don’t we just own the minority of funds that have already proven they can deliver?

Let’s reality-check that notion with the S&P Persistence Scorecard. This tracks the ability of active fund managers to maintain a winning streak.

% of active funds in top quartile for four consecutive years 

SPIVA study bar chart that shows a tiny percentage of equity funds can maintain their top quartile ranking over 4 years

Source: S&P. “SPIVA Europe Persistence Scorecard Year-end 2021.”

The chart shows that retaining your place in the top 25% is a contest played with more ferocity than Squid Game

After just four years, only a sliver of active equity funds remained near the top of their league table:

  • Europe equity: 2.77%
  • Eurozone equity: 1.45%
  • Global equity: 4.31%
  • Emerging Markets equity: 1.3%
  • US equity: 1.41%
  • UK equity: 3.57%

Hmm. Perhaps the casualty rate is less brutal if you restrict the analysis to funds with a three-year outperformance record?

Can those best funds continue to beat their benchmarks for the next three years?

Not so much…

Outperformance persistence over three consecutive years

Equity sub-asset class Total funds Funds outperforming 2018 Same funds still outperforming 2021
Global 1075 70 6
UK 358 79 37
US 289 27 1
Europe 1030 166 23
Emerging Markets 322 45 0
Eurozone 569 69 10

Source: S&P. “Europe Persistence Scorecard Year-end 2021.” 

Only UK equity has a halfway respectable percentage of its 2018 winners still winning in 2021 – 47%.1

Global equity winners are scythed down to 9%. The US has only 4% of its 2018 market-beaters still standing. The Emerging Markets have none. 

Active fund management sees more reversals of fortune than a Russian Roulette tournament. 

SPIVA criticism

It probably hasn’t escaped your attention that the SPIVA research is undertaken by S&P Dow Jones Indices. 

And S&PDJI earns a large slice of revenue by licensing indices to index tracker firms. 

So of course, it’s in S&P’s interest to demonstrate that active funds are falling short. 

But does that mean the SPIVA study is corrupt? 

No, it’s highly respected within the investment industry and attracts remarkably little criticism. 

One of the reasons the study has survived since 2002 is because S&P has updated its SPIVA methodology and addressed some of its biases. 

There’s an interesting discussion of SPIVA’s potential flaws in the paper Uncovering Investment Management Performance Using SPIVA Data by Shah, Wanovits, and Hatfield. 

While the paper’s authors refine SPIVA’s methodology, they concede it’s directionally correct, concluding:

Regarding the passive active debate, we find that passive funds generally outperform active funds in the long run, any advantages of active funds are wiped out by the fees. Only under a bear market does active funds demonstrate an advantage. It does bring into question the value that active fund management brings to investors. 

If you’re relatively new to investing and would like to know more about the active vs passive debate then start by learning:

The paradox of skill

Active fund managers are not frauds. They are exceptionally talented and hardworking as a group.

Yet most of them do not beat the market consistently after deducting their fees.

The odds – and the competition from all the other exceptionally talented and hardworking managers – are stacked against them.

But why is outperformance so elusive even for the odd winning fund? Professor Jonathan Berk from the Stanford School of Business says:

If investors find a manager who can consistently beat the market, they will flock to invest with this manager. Eventually, the manager will have so much money under management he will not be able to deliver superior performance. Competition between investors drives the managers return down to the return investors could earn by themselves.

A hot manager becomes such a cash magnet that they have too much money to invest.

Their prior success was based on picking a combination of assets that was overlooked by the competition. But the torrent of new money erodes their uniqueness.

Their portfolio ends up looking like everyone else’s. Mediocre performance follows.

The manager falls down the league table and investors redirect their capital to the next shooting star.

Warren Buffett puts the challenge of picking winners more succinctly:

The problem simply is that the great majority of managers who attempt to over-perform will fail. The probability is also very high that the person soliciting your funds will not be the exception who does well.

Low-cost index funds solve the problem. 

Take it steady,

The Accumulator

  1. The slightly higher propensity of UK active funds to beat the market may mostly be because they hold more smaller cap shares than the index, which is dominated by a handful of giant firms like AstraZeneca, HSBC, Unilever, and Shell – The Investor. []
{ 36 comments… add one }
  • 1 Quincel August 30, 2022, 1:10 pm

    These numbers are just nuts. It’s incredible the fund management industry has largely survived 20 years of this. I wonder where it will be in another 20 years, it certainly feels like the internet and other factors have made high fees for below-index returns less acceptable (and fees have already fallen).

  • 2 Jim McG August 30, 2022, 2:51 pm

    It was data like this that persuaded me to invest in Index Funds over twenty years ago. I thought active funds we doomed at that point. But here we are, billions still being invested into “star” fund managers hyped up in the press. Even the Woodford experience, which was about as high profile as I’ve seen in the media, did nothing much to change things. Maybe it’s a good thing though, it would be pretty boring if there weren’t fund managers to scorn and compare our sleep-inducing passive portfolios against.

  • 3 JDW August 30, 2022, 5:45 pm

    Really interesting read.

    @Quincel The fund management industry will survive IMO (let alone because they, in the most part, also offer passive options). This is a quiet backwater, dont forget. Lot of people don’t even know they are shareholders, in the form of opt in via workplace pension schemes (something like 78% of people have a workplace pension according to ONS I think). I would wager the majority of people still just see the word pension on their payslip and zone out, completely unaware their pension is a) in shares and the stock markets and b) in a managed fund. Imagine the figure unaware is slowly falling but a trickle rather than a flood. Enjoyed a conversation at work recently with a do-goer (genuinely a lovely person) who supports the ultimately well-intentioned but pointless sitting outside a petrol station protests, but still drives a petrol car and she’s openly angry about the energy giants reaping insane and arguably unjustified profits during a cost a living crisis. I asked her if she had a pension, to which she replied in the positive but ‘didn’t know anything about it’. Could visibly see her face drop when I said her well accumulated decades old default workplace scheme was very likely 1) investing in fossil fuels and the very energy giants she is against, b) very expensively managed by a large fund management company, as the post shows and we all know, is unlikely to perform better than the index.

    Discovering Vanguard LS80 genuinely changed my life. The case of passive is overwhelming by every metric, although I so still like a small dabble in active.

  • 4 Stephen Francis August 30, 2022, 7:33 pm

    Thank you for a very interesting and compelling article.

    In the interest of full disclosure, I am an IFA. Advisers are brainwashed about the value added by fund managers. To an extent, to deny this added value raises the more uncomfortable question about the added value we IFAs can add. I use a blend of active and passive funds but am increasingly focussing on passives despite some misgivings.

    Over the years, I have seen the rise and fall of many superstar funds; Invesco High Income, Fidelity Special Situations, M&G Recovery, to name a few. The portfolio research we use aims to keep ahead of these changes. This works to an extent but, just as it is questionable whether fund managers add value, this also applies to portfolio managers. At best, my belief is that the added value about keeps up with the added costs incurred, possibly with some risk management benefit.

    One question I have not seen asked concerns the ethics of passive fund management. In an efficient market, the argument is that its associated index represents the average of all investors. They are assumed to make rational decisions about the merits of one company vs others. Essentially, the success of a tracker fund piggy backs on the huge investment in research by active managers. Essentially, taking a free ride. While I have no doubt of the efficacy of this, could it not be considered a little unfair on all the active managers who make the market work efficiently?

    Investment in funds comprising say the S&P 500 are split between active and passive investors. As the proportion shifts towards passive investment, the question arises what they are tracking. If one tracker fund adds to its holding of a particular stock, others will be compelled to follow suit to avoid a tracking error. In the extreme, all money would converge on the largest company to the exclusion of all others with no consideration of economic fundamental factors.

    Finally, unless relying entirely on a global all-stock tracker, you still have to take an active decision about asset allocation and the level to which you might include a bias towards local indices to reduce exchange rate risk. The inclusion of fixed interest funds raises many more questions; duration, grade, geography, gov vs corporate bonds etc. All active decisions.

    I welcome your views on these points.

  • 5 JRN August 30, 2022, 7:55 pm

    The data looks compelling but, if you look at US equity the JPM American Trust has out performed the S&P 500 which it is benchmarked against over 1, 3, 5, and 10 years ? Not what the all green chart for North America shows!

    Overall trackers do win, but, I do wonder what in this case risk adjusted returns really means.

  • 6 Hariseldon August 30, 2022, 9:42 pm

    There is no arguing the basics of the research, however it is more nuanced.

    If an active fund has a well defined investment policy, Peruvian small value stocks perhaps, then it needs to be compared to an appropriate benchmark, that may be more difficult than it looks.

    The costs element for an investment trust is often outweighed by a canny purchase at a discount, the use of gearing by a trust can offset the costs…

    For most investors the index fund is an excellent choice, there are active funds that can provide valuable benefits, perhaps complimenting a core index strategy.

  • 7 White Sheep August 30, 2022, 9:56 pm

    When I first started to invest I didn’t know much about it. So the first step was to go to my bank to make enquiries. They told me that they wanted 5% up-front to invest in a fund they couldn’t tell me anything about. That didn’t sound very attractive so I figured out that I could reduce the fee to 1.25% if I went to a fund supermarket. But what to invest in? The financial press only had seemingly random tips by long lists of alleged experts. The only common theme seemed to be that every expert recommended a different fund, and nobody ever seemed to follow up to check the success of any recommendations. It seemed very strange to me even at the time, but I had to start somewhere so I bought some random funds.

    Twelve years ago I had a revelation when – while on a business trip – I was browsing an airport bookstore and came across a book by a certain John C Bogle. I bought and read the book and suddenly it all seemed to make sense. On average funds produce market returns minus the costs, and it is very hard to identify outperformers before the fact. So best to take the market return and invest passively.

    (My second investing revelation was when I discovered Monevator a few years later. 🙂 )

  • 8 Valiant August 30, 2022, 10:50 pm

    Could someone explain the logic of this assertion for me please?:
    “If investors find a manager who can consistently beat the market, they will flock to invest with this manager. Eventually, the manager will have so much money under management he will not be able to deliver superior performance. Competition between investors drives the managers return down to the return investors could earn by themselves.”

  • 9 mr_jetlag August 31, 2022, 1:44 am

    @Valiant – a money manager may have a strategy that works for a certain size of trade and type of portfolio – which is why NAV and AUM are important things to consider. A manager whose strategy works for $1Bn of AUM may struggle to implement it at 10Bn.

    For example, they may not be able to place a trade 10x bigger (no liquidity / counterparty risk). They may not be able to deploy cash as efficiently (cash is a drag on returns). These factors compound and the same fund or manager that outperformed at 1Bn could trail the benchmark at 10Bn.

    Also there’s simply reversion to the mean – very few funds consistently outperform the index, and those aren’t usually individuals but *systems* (Millennium and Renaissance are known examples, there are more obscure ones that don’t even market to investors and are run purely for the partners).

  • 10 mr_jetlag August 31, 2022, 1:57 am

    @Stephen Francis: ” If one tracker fund adds to its holding of a particular stock, others will be compelled to follow suit to avoid a tracking error. In the extreme, all money would converge on the largest company to the exclusion of all others with no consideration of economic fundamental factors.”

    There are strict limits to single issuer & sector concentration in most mutual funds and even the most passive tracker allows for some tracking error / rebalancing as allocations shift eg when Blackrock/Vanguard trade in/out of TSLA vs F.

    That means that there are safeguards against all the money in tech being invested in AAPL or MSFT, because capital markets have a monopolizing tendency anyway and the funds are setup to recognize this.

  • 11 Vic Mackey August 31, 2022, 9:18 am

    The first chart details something called “Risk Adjusted Returns” without any definition of what that actually means. I assume that we’re not just talking plain vanilla net of fees returns? Have the numbers been manipulated to take into account volatility? If so any conclusions drawn will surely be more nuanced.

  • 12 Jonathan B August 31, 2022, 11:40 am

    @Stephen Francis, you don’t need to worry about whether IFAs add value in general, just make sure you do. Suggesting specific funds is second order advice, the real value is in getting clients to look strategically at their aims, preferences, and risk tolerance. At that level there are active decisions (like proportion of bonds, geographical spread, etc) which most people need informed guidance to make. Once that is decided the actual investments could be active or passive, with passive being the better bet for most people. But not everyone, indexes are poor when it comes to some things like a wish to selectively avoid fossil fuel companies or polluters.

    And passive investments probably won’t be the answer for those who have high risk tolerance, essentially gamblers. But those are unlikely to pay an IFA for advice.

    You may be right about odd outcomes in the hypothetical case that every single shareholder in an entire market is a passive fund following an index-tracking methodology. But we are not there, and not likely to get there. It doesn’t need a “huge investment” (and consequent high fees) to discover companies’ profit margins and dividend records, and I can’t imagine a world in which some investors won’t be guided by those factors.

  • 13 The Investor August 31, 2022, 1:27 pm

    @Stephen Francis @Jonathan B — Jonathan writes:

    You may be right about odd outcomes in the hypothetical case that every single shareholder in an entire market is a passive fund following an index-tracking methodology. But we are not there, and not likely to get there. It doesn’t need a “huge investment” (and consequent high fees) to discover companies’ profit margins and dividend records, and I can’t imagine a world in which some investors won’t be guided by those factors.

    To this point, the US market had (from memory) about 150 professionally managed funds in the 1950s, versus probably north of 10,000 today if you count all the different flavours.

    The market may have been a little more inefficient then, but most of that was probably due to huge informational issues (Warren Buffett having to take the train to New York to look up historic price-to-earnings ratios in the library or whatnot). Short of an apocalypse those barriers aren’t coming back.

    I don’t know exactly how many highly-resourced active funds stuffed with super-bright managers competing with one another are required to keep the S&P 500 functionally efficient, but I’m confident it’s closer to 150 than 10,000.

  • 14 Stephen Francis August 31, 2022, 1:41 pm

    @Jonathan B. I agree that financial planning has to be more about the ‘planning’ and less about being some kind of investment guru. If there is a focus of my advice it is about helping clients towards a position of financial wellbeing. To this end I also volunteer to present workshops at schools on financial matters in conjunction with the CII. The more radical part of me leans towards the FIRE movement in the US and the merits of minimalism.

    Where appropriate, I encourage clients to consider property investment alongside the usual ISAs/Pensions. This is because I have seen more ordinary people gain early financial independence with a few buy-to-let properties than from any other means. For higher earners I also recommend VCTs to provide tax-efficient income and avoid income tax (legally!).

    On the active vs passive debate, active funds tend to do better in volatile markets and in less efficient markets such as EM or smaller companies.

    I see that in the US, passive funds now account for 16% of capitalisation compared to 14% for active funds. Ten years ago the split was 8% passive to 20% active. As you say, this is not likely to be a problem but will be an influence and something to keep an eye on.

  • 15 The Investor August 31, 2022, 2:11 pm

    On the active vs passive debate, active funds tend to do better in volatile markets and in less efficient markets such as EM or smaller companies.

    No they don’t.

    They certainly don’t do better than index tracker funds in their sectors. They might do better relatively than active funds in more efficient markets if that’s what you mean (actually, they still don’t).

    For the 15-year period ending June 2019, 90.3 percent of all actively managed small-cap funds and 94.3 percent of actively managed emerging market funds under-performed their benchmark index. That’s even worse than the 87.8 percent of all domestic fund managers who failed to beat their respective benchmarks, and even more than the 89.8 percent of all large-cap domestic fund managers who failed.


    As for volatility:

    Investors in actively managed funds are being hit harder by the 2022 sell-off than those tracking the index, research by Trustnet reveals, despite arguments that active managers are better to able to protect on the downside.


  • 16 Jonathan B August 31, 2022, 3:35 pm

    @TI, while I agree that a modest number of active managers would be enough to create a sufficient market for indexing to work, the 1950s were a different world. I suspect a much higher proportion of shares were held as individual holdings by private investors who didn’t do the in-depth research. It might be more relevant to ask what proportion of the market needs to be held by individuals/managers capable of responding quickly to changing value indicators for pricing to be efficient.

    @Stephen, interesting that your advice encompasses property investments. Clearly they have been beneficial to many, but there are also horror stories. I don’t know how you incorporate them in an overall strategy alongside more liquid funds. IFAs also seem keen on insurance-based investments (confusingly labelling them as “bonds”) so I assume they find those less opaque than I do. By the way I applaud your work in schools, there is too much ignorance about financial planning and it is good that at least some are getting a basic grounding early.

  • 17 Seeking Fire August 31, 2022, 3:36 pm

    Thanks for the article. The evidence really is overwhelming.

    For the vast majority of equity indices, passive fund management is the best route forward. My instinct though is the real issue of active fund management is not just the costs, it’s the fact that people switch to chase yesterday’s winner’s, which as the evidence shows is actually a strategy to buy tomorrow’s losers.

    One exception to that I think would be AIM in the UK. Were I to want to invest in micro-cap’s I’d do it actively not passively. The index seems to have gone no where in 22 years broadly because so many poor IPO’s have come to market. Of course that does also mean the active funds have been buying them! Note FTSE Small Cap is not AIM.

    I slight detour here though….asset allocation is even more important I think, i.e. buying a run of the mill active S&P500 fund would have been better than a FTSE 100 tracker over the last twenty years for example.

    @14 Stephen Francis – thanks for the note. Which VCT’s specifically? All the evidence / analysis I’ve seen / done has shown that the costs seems to eradicate the taxation benefits. Plus the fact that pensions have been curtailed for high earners has increased the VCT flow, which generally leads to poorer performance as managers need to invest. It’s not tempted me for that reason but interested in your perspectives.

  • 18 Stephen Francis August 31, 2022, 4:11 pm

    @TI. Great response and evidence. I still have a lot of ‘unlearning’ to do!

    @Jonathan. Property can be a dreadful investment; illiquid, high cost, tax inefficient, and you have to deal with awful tenants, bad debts and damage – so why bother? There are three key benefits:
    1.The power of gearing. I would typically pay 25% deposit and borrow 75%. A 5% gain in value = 20% gain on my equity. With a loan interest of 3% and yield of 8%, I make 5% profit on the banks money.
    2.Buying below market value. This is not strictly true as the market value is whatever a property sells for. But, some sellers are more motivated than others. A probate sale or an acrimonious divorce may mean a quick and easy sale is worth accepting a low offer for. There is no magic to this, just lots of offers until someone says yes or at least accepts a price with in-built profit.
    3.Improvement or development. Ugly houses or ones in poor decorative order or just cluttered can often be bought cheaply and easily improved. In some, value can easily be added by development or even building another house in the back garden. Personally, I prefer to do relatively little as I want tenants to be in within about a month of completion. Still, you can do quite a lot if you plan well before the completion date and get cracking.

    Investment bonds are only useful if a trust is called for. Trusts are really useful things for estate planning or asset protection. However, tax on discretionary trusts (in particular) is horrible. Bonds can avoid this. Discounted Gift Trusts using bonds are brilliant as a way of giving away capital to avoid IHT but retaining the income they generate. Have your cake and eat it!

    @Seeking Fire. The only ones I use are from Octopus, a company I greatly respect. Yes, fees are horrible but that is a fact of life with AIM or unlisted securities. Risk is high but much less than with EIS or SEIS. I use Titan and Apollo and, for ethical investors, their new Future Generations VCT. Tax shouldn’t be the tail that wags the dog, but is an important factor. Consider this as an example: you predict your future income tax will be £3,000 per year. So, this year you invest £10,000 in the Titan VCT (which aims to pay 8% p.a. dividend). Tax relief is 30% i.e. £3,000 so wipes out your income tax. You do this for the next four years. Assuming no capital growth, this, alone, gives you annual income of 5 x £10,000 x 8% = £4,000 tax-free, for a net investment of 5 x £7,000 = £35,000. VCTs need to be held a minimum of 5 years to qualify for the tax benefits – or they’ll be taken back! After 5 years, the year 1 VCT can be encashed and reinvested in year 6 – and so on. There are other considerations, yes, including fees, but elegant nonetheless.

  • 19 Stephen Francis August 31, 2022, 5:35 pm

    @Seeking Fire. A correction re the Titan VCT. The target dividend is 5% p.a. The 8% paid last year, in addition to 24% capital growth, was an exception.

  • 20 ZXSpectrum48k August 31, 2022, 6:22 pm

    @TI. Regarding your replay to the question “On the active vs passive debate, active funds tend to do better in volatile markets and in less efficient markets such as EM or smaller companies.”
    You replied “No they don’t.”

    I have to disagree with you. I don’t think you can actually say anything useful based on reports like SPIVA (or similar ones). The complexity of the measuring performance is far more difficult. Take their EM debt category. They benchmark against the market cap Barclays EM index which only a few cheap retail funds use. Over 90% of the market uses one of a plethora of JPM EM indices which are not cap weighted but DJ cannot access since thry have substantial subscription costs. You can see the nonsense their report generates because according to them 100% of active funds EM local funds underperform the index. That’s statistically rather unlikely! It’s because the Barclays local index is just not replicable.

    You fall into similar problems trying to measure performance of global bond funds that often index against sensible capped indices with partial FX hedging, rather than some nonsense market cap weighted index.

    SPIVA is useful for a limited universe of simple funds that tracks domestic equity indices or domestic bond indices. Beyond that it’s value degrades rapidly.

  • 21 Pat August 31, 2022, 7:54 pm

    Hi Seeking Fire. I have been investing in VCTs for almost 10 yrs. Go to the AIC site select the VCT generalist option and tick on the 5yr best return button ( to make the most of VCTs you need to rinse and repeat every 5yrs for the tax refund ). You have at least twenty good investments there, especially if you are a high tax bracket.

    Good luck,


  • 22 Seeking Fire August 31, 2022, 9:46 pm

    Stephen Francis / Pat – Many thanks. I remain a little sceptical given the fees issue but will continue to take another look.

  • 23 JRN August 31, 2022, 10:30 pm

    “Risk adjusted return is computed as annualized average monthly return divided by annualized standard deviation of the monthly return for the measured periods”

    Why you would need to do that for 10 year periods mystifies me.

    Information presented prior to an index’s launch date is hypothetical back-tested performance, not actual performance, and is based on the index methodology in effect on the launch date….Actual returns may differ significantly from, and be lower than, back-tested returns.

    I am sure that this doesn’t detract from the fundamental conclusions but the JPM America Trust example I gave earlier is probably not the only one like that

  • 24 The Accumulator September 1, 2022, 11:11 am

    @ JRN and Vic Mackey – SPIVA also publish absolute returns (i.e. not risk adjusted) in the same report. Here’s the numbers:

    Active funds outperformed by benchmarks over 10 years.
    UK equity: 62%
    Global equity: 90%
    US equity: 95%
    European equity: 74%
    Emerging Markets: 86%
    UK Small Cap: 58%

    So the numbers are similar to the risk-adjusted returns but active managers do slightly better this time. Why? Because of the risk-reward trade-off.

    Take more risk and you can hope to earn a greater reward. But sometimes those risk chickens come home to roost. Taking risk isn’t as simple as saying: “Yeah, I’ll take more risk then” and waiting for the rewards to come rolling in. Volatility panics people. It causes them to bail out on a strategy. Then you’ve realised the risk and not the reward.

    I think it’s important to test claims of high returns against the risks taken to achieve them. Without risk adjusted returns it’s relatively straightforward for a fund manager to claim to beat a broad market benchmark for a while. Take one leveraged fund and pack it full of dynamite illiquid small growth stocks that go off like a rocket. Then compare it with a benchmark that embeds less risk. But people can quickly find themselves out of their depth when the strategy blows up later.

    @ Stephen Francis – I do think IFA’s can add value around devising, implementing and maintaining an investment strategy for people who can’t or don’t want to do it themselves. Investing is counterintuitive and grindingly dull for most people so I’d guess a large segment of the population welcomes guidance.

    I agree that people have to take many individual decisions which aren’t helpfully framed by ‘active vs passive’ debates. So yes, I have to decide whether my portfolio includes 40% government bonds or not.

    But as a passive investor I’m not doing it because I think that will gain me a temporary advantage in the market. I’m doing it because I understand that’s approximately the right amount to manage my risk. That’s a decision I need to make, possibly with the help of an advisor, but it’s not ‘active’ because ‘active’ in the context of this debate means trying to beat the market.

    I’m doubtful that most advisors can pick successful managers. Berk’s comments on investors competing against each other applies equally to advisors competing on behalf of their advisors. Also see David Swensen and Buffett on the slimness of your chances.

    I think there will always be active investors engaged in price discovery. As others have noted the industry is in rude health. The potential rewards for success are huge so I don’t see active investors giving up and going home.

    I also don’t see how the existence of tracker funds is unfair. They’re not competing with active investors. However, active investors are competing against other active investors. If my mum’s pension is invested in active funds she’s exposed to a competition she’s only going to lose. Ditto almost everyone else from civvie street including public sector pensions and novices who sign up to free trading apps thinking they’re gonna get rich.

    There is an ethical dimension to this and it’s that index trackers are part of the common good. Like clean running water, electricity, the internet and many other wonders of the modern world that we take for granted.

  • 25 Naeclue September 1, 2022, 11:17 am

    Investing in actively managed funds is very likely to produce worse long-term returns than investing in passive funds (all else being equal). This is a well established fact and should not be a matter of debate. The only people who insist on saying there is a debate to be had are reality denying muppets and those with a vested interest.

    This is similar to other situations where the word “debate” is being misused – climate change debate, evolution by natural selection debate, Apollo moon landings were faked debate, etc.

    It is of course essential to passive investors that there are active investors prepared to take on the costly burden of price discovery, so passive investors should not be too disparaging. Thankfully though human nature is such that there should always be enough muppets willing to do this.

  • 26 Stephen Francis September 1, 2022, 12:11 pm

    @TA,@Naeclue. The biggest risk to investors is their own psychology. Investment timing has been shown time and time again to be a fruitless exercise because short term market movements are so much down to the fickle nature of sentiment. Worse still, though most people would agree that it would be best to buy when markets are cheap and sell when expensive, their natural inclination is to do the exact opposite. They gain confidence as markets steadily climb, enough to dive in and invest just as they are about to fall, only to sell when at the bottom in the hope of avoiding further losses.

    A key element of my role as an adviser is to help clients overcome this self-destructive behaviour; to do the right thing at the right time even if it might be uncomfortable.

    Regular contributions help by pound-cost averaging but, otherwise, the right time to invest is simply when you have the money to do so after allowing for a sufficient cashbuffer as a contingency fund.

    Another key consideration is risk. Risk attitude can be adventurous as markets rise only to collapse once values decline. Investors are either too adventurous and have too much in equities (I suspect many here will be guilty of that!), or too cautious and fearful of loss, not appreciating the loss in real terms faced by cash deposits.

    Both greed and fear are enemies of good financial planning.

    Few understand the power of rebalancing and how this automatically times the market. This only works if you have a blend of Equities and Fixed Interest funds (or any other non-correlated alternative). With a 60:40 portfolio, if equities are ‘overpriced’, rebalancing sells some to buy more FI funds to bring the portfolio back to 60:40 and vice versa. Each time, buying low and selling high. Worth noting though that high yield bonds might look attractive but are highly correlated to equities so don’t help much in risk management.

    @Naeclue. I have been thinking about your challenge to the word ‘debate’ relating to the active vs passive investment choice. I agree that it is probably the wrong word. Advisers want to do the best for their clients but are indoctrinated to believe in the value of active management and increasingly in discretionary portfolio management. We implicitly feel these should work. The evidence, of course, is against this. We then argue that it is down to market conditions. Again, the evidence is against this. Perhaps it is more down to education rather than debate and humility to accept such compelling evidence.

  • 27 The Accumulator September 1, 2022, 2:07 pm

    @ Stephen Francis – I agree wholeheartedly. I think many of us suffer from cognitive dissonance to an extent. Many Monevator readers buy into the efficiency of global trackers but try to achieve an edge somewhere with an infrastructure fund here or a private equity fund there. Perhaps a bit of crypto, a couple of investment trusts and a smattering of shares. Most likely it’s a very human hedge against uncertainty.

    I know a couple of IFAs in the same boat who use trackers for the bulk of client holdings and then ‘add value’ with a slice of active funds.

    I’m no exception because I invest a percentage in risk factor ETFs which I accept is active investing.

    I well remember John Bogle weighing in on the ‘Smart Beta’ debate before I first took the plunge. He said: “Don’t do it.” He was right!

  • 28 ZXSpectrum48k September 1, 2022, 3:36 pm

    @Naeclue. If I’m a muppet how is that even academic papers show that actively managed currency overlay managers outperform their indices? See https://www.bis.org/publ/bppdf/bispap58j.pdf

    Or that the hedge fund index has outperformed a 60/40 portfolio over the last two decades? See this link https://ibb.co/pXjRzNW

    This isn’t like the debate on climate change. Yes if you stick to simple asset classes like large cap equities and domestic bonds, then it’s very hard to argue that active management will produce higher returns than index tracking. Once, however, you move away to much larger markets, which are not asset classes necessarily, such as FX or interest rate swaps etc this is not the case. You have clear segmentation of aim between economic agents (funds) and non-economic agents (hedgers). There is no theoretical reason to believe that in such markets active returns are not achievable and empirical data supports that.

    In the early part of my career (late 90s), I spent my time talking to large pension and life companies about how to replicate the US Treasury market, Gilt market, even EM sovereign debt markets with a handful of bonds or bond futures to a tracking error of 25-50bp. The aim was to get them to dump their fund managers who they were paying 2% and manage the money themselves. Our benefit was that, in return, they would obviously do their trades through us at the end of every month. Every bank was at it. It was so successful that Blackrock et al had to respond and they all came out with passive products.

    Personally, I don’t want to invest in “hard” markets such as bonds or equities when there are “easier” markets such as FX or interest rate derivatives where I can achieve good returns. Moreover, how would you even replicate a fund such as Millennium or Bluecrest using a index tracker? Please tell me since everyone would love to know how to generate massively higher returns than the S&P with a fraction of the volatility.

  • 29 Naeclue September 1, 2022, 10:31 pm

    @ZXSpectrum48k, thanks for the straw men.

    I am now sitting in a boat with my mobile and a poor Internet connection and don’t feel inclined to wade through that paper in any detail. However, the gist of it seems to be that someone has constructed indices from systematic currency trading strategies and then goes on to compare the returns on those indices against a selection of currency traders, possibly a self selected set based on survivorship bias and a willingness to provide return data (or possibly not, I don’t really care either way). Then low and behold, the currency traders do better than the constructed indices. Is that about right? If so, what on Earth has it got to do with SPIVA scorecards, or the long established fact that the long term returns from actively managed funds are poor compared to returns of the securities MARKETS that the funds use to create their portfolios?

    For the chart you linked to, which cherry picked HF index are you comparing the return on a 60/40 fund to? Whatever it is, the results for the last 10 years don’t look particularly impressive to me. Maybe the next 10 will make up for it? Not the sort of risk I would want to take on.

    As for returns on FX, swaps and derivatives, then yes I agree money can be made in these markets as there is a natural flow between parties wanting insurance and those willing to provide it. Not always one way of course, but over time, in aggregate, this has to be the case to attract the insurance providers who are not going to work for nothing. However, some of the risks taken on by providers may not show up in vol or historical VaR calculations. I have witnessed a fair number of instances where a trading desk is running along nicely, VaR comfortable, and then boom. Usually after the fact though when the firm or bank decided they needed their risk management overhauled. Again, none of this has much to do with funds investing in securities markets underperforming those markets.

    Personally I want to invest in what you describe as “hard” markets with as few middlemen taking a cut of returns as possible, to invest where I can be completely hands/eyes off from one year to the next and without carrying the additional risk of an active fund manager significantly underperforming the market. Or worst still blowing up through shorting, mad gearing or dabbling in derivatives markets. Physically replicated tracker funds fit the bill nicely.

  • 30 Naeclue September 1, 2022, 10:52 pm

    @Stephen Francis, would it be fair to say that the indoctrination you mention is rooted in the commission that used to be paid to IFAs from actively managed funds? If so hopefully advice based on evidence/reality might gradually emerge now fund commission has been banned.

    I would have thought that a far safer thing for an IFA to do would be to advise investment in trackers. Otherwise they risk having to explain significant underperformance, which is bound to happen every so often even if the majority of recommendations were better than average.

    OTOH, I guess a client may come along with a chart showing a top performing fund and demand an explanation as to why he was advised to put his money into a tracker! (At least there is a rational answer to that challenge)

  • 31 The Investor September 2, 2022, 12:51 pm

    @ZXSpectrum48K @Naeclue — I have to agree with @Naeclue here. I won’t say much more as it will just repeat everything I said in our recent discussion about hedge fund benchmarks. But in short, while I find your points intellectually interesting, I don’t see that they have much relevance to the thrust of our ‘active funds almost invariably lag’ posts (whether hedge funds or otherwise) nor that even if they did it would be of any practical consequence to 99% of readers who cannot access the funds you tend to cite, and would be poorly placed to choose between them even if they could.

    Am I intrinsically skeptical that in today’s hyper-competitive markets there is easily accessed alpha lying around even at the institutional level? Absolutely I am, but it is far above my pay-grade to argue the toss with you about that.

    Do I think off-benchmark portfolios can beat benchmarks, while (potentially) raising a measurement/tracking problem? Absolutely, but at the same time this has long been a refuge of mainstream Fear and Confusion in the retail fund market. For example, the UK equity income fund manager who is allowed to allocate 10% of their portfolio to overseas stocks and rides Microsoft for a decade, while flagging their general stock picking talent.

    Similarly I could own 95% of my equities in a global tracker and have 5% in Amazon. This possibility would have walloped the market over the past couple of decades. Should we caveat accordingly? 🙂

    Here you’re talking about a very specific kind of fund, which also happens to overlap your area of professional expertise. I have no reason to doubt everything you’re saying is true for you. But when you’re talking about an exposure that doesn’t include mainstream assets like equities and bonds, then I think it’s time to heed Wittgenstein’s timeless advice: “What we cannot speak about we must pass over in silence.”

    Imagine this was a blog about how to drive safely on the British roads. An analogy might be that you’re Lewis Hamilton, popping up to say it’s very possible to take sharp corners at over 100km/h.

    Well maybe Lewis Hamilton in one of two dozen F1 cars in the world can do that, but that’s of little practical relevance to anybody else.

    Similarly I don’t think we should start endlessly caveating our articles because of a vanishingly small amount of active money that most people and even most institutions can’t or won’t successfully access, just because it apparently happens to have attractive risk/reward characteristics right now.

    From experience I expect you won’t be hugely satisfied with the answer, but hope it explains to anyone interested my thinking on this. 🙂

    All the best!

  • 32 Naeclue September 2, 2022, 8:04 pm

    It is perfectly possible for a majority of funds to outperform the market if a lot of big funds underperform small funds, but it does not happen very often.

    For a simple illustration of this, consider a market with 3 active funds A, B and C. A starts off twice as big as B, B and C are equal size. Let’s say the market returns 11% and the aggregate return of A, B and C is 10%, reflecting the frictional costs of the funds. If that return is split into zero return for A and 20% return for B and C, then 2 out of the 3 funds will have beaten the market, even though Sharpe’s Arithmetic of Active Management still holds.

  • 33 ZXSpectrum48k September 3, 2022, 10:18 am

    @Naeclue. These are not selected HF indices. That is the global HF index, everything, and it’s outperformed net of fees, normalized for volatility. If I take out equity HFs, it would have outperformed even more. Most HFs have a volatility of one third to one quarter of stocks, they have a low correlation with stocks. They have been a great replacement for bonds in a 60/40 portfolio. Yes, they performed poorly in the low vol period of 2014-17 but as you can see they made up for that in the higher vol periods.

    I buy my bonds and equities almost totally through trackers because it’s easily replicable. That’s the key though. Active investment rarely works where you can easily replicate. It works much better where you cannot replicate or is often the only choice. Many investments though are not easily replicable. For example residential property. Why only look at bonds and equities?

    I would never want to have a large percentage of my assets in bonds or equities. They have a terrible Sharpe ratio and you can take large drawdowns. It’s avoiding large drawdowns that’s the key to long term performance. Moreover, compared to a Vanguard tracker which is taking huge systemic risk lending out it’s porfolio for a few basis points, my funds are 90% in cash, have a 5% stop loss, and make money when systemic risk hits. Just far safer.

    As for Sharpe’s arithmetic of active returns, it’s clearly got more holes than Swiss cheese. Take simple example. Bond is issued. I buy it. Price goes up. Enters index at end of month. I sell it to index fund. I’ve made money. Index tracker hasn’t lost money vs. index. This violates Sharpe’s paper. Happens all the time. It’s a useful toy model but it’s not reality.

    I’m being moderated now so this comment may to may not appear. I just don’t understand this attitude that it’s ok to take potentially massive drawdowns on your portfolio by having big exposures to assets like stocks or bonds. This attitude that somehow there is no other choice but to accept large losses at some point. But there are. I’m deeply risk averse and would never want to lose more than 5% from high to low. I’ve been able to use these funds to manage that risk and still achieve double digit returns over 20+ years. Universa was investible at just the $100k level 10 years ago. That returned over 1000% in 2015 and 3000% in 2020. How hard was it to even put a one percent of your portfolio in that or few percent in Millennium say?

    I agree with @TI it’s pointless me making any further comments. Heterodox views are no acceptable even when there is data to support them.

  • 34 Naeclue September 3, 2022, 4:03 pm

    @ZXSpectrum48k, global HF index, thank you. Not sure how I would go about investing in that index, but that’s another matter.

    Hard to do this properly on my phone, but the Eurekahedge global index EHFI601 produced a total return of 38% over 10 years to end 2021, compared with 189% for Vanguard’s 60/40 fund VBIAX. Admittedly this year the HFs have been doing better, with the Vanguard fund down 17% in the first half compared with only 4% for EHFI601. Every dog has its day. The last big 1 year meltdown in 60/40 was 2008 with VBIAX down 17%, compared with a 15% drop in the HF index.

    Forgive me if I am not overwhelmed with enthusiasm for hedge funds.

    As I am sure you are aware there is a lot more to risk than Sharpe ratios or other volatility derived metrics. To take the extreme case, can you point me towards any cap weighted funds that went pop through poor management or fraud? How many instances of hedge funds collapsing are there?

    Another exame of Sharpe silliness is if I took bets with a 99% chance of a 10% payoff and 1% chance of a total wipeout, Sharpe would likely look great for quite some time, right up until that 1% arrived.

  • 35 Onedrew September 4, 2022, 10:50 am

    @TI I have learned a lot from ZXSpectrum48k over the years, especially about bonds. I have been particularly excited about their reporting of making excess returns through means other than equities and bonds, but have always guessed that these were specialist investments that we mostly mainstream retail punters would not be able to access and therefore somewhat irrelevant to Monevator punters. If this guess is wrong, I would be excited to get a better glimpse into this alternative world. It is a shame that there seems to be a rift in the lute atm, but I get it.

  • 36 The Investor September 4, 2022, 12:05 pm

    @Onedrew — I value all @ZXSpectrum48k’s comments, including the ones where I feel (for wider reasons connected to the mission/readership of this website, as opposed to if we were having a chat over lunch) I must make some kind of counter. It’d be a loss to our website if he stops commenting.

    But online discussion can be frustrating, for a host of well-documented reasons. I wouldn’t blame anyone for wanting a timeout.

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