Jay D. Franklin

Manager Picking is a Mug’s Game

Once again, Standard & Poors has issued their Standard & Poor’s Indices Versus Active Funds Scorecard (SPIVA ®) and the S&P Persistence Scorecard report on the performance of active funds, adjusted for survivorship bias. For those who believe they can pick the next winning manager in any category, the results are not encouraging.

For the last five years (the longest period analyzed), 71.6% of all domestic equity funds failed to beat a style-based benchmark. Of the 2,104 that existed at the beginning of the period, 525 (25.0%) were either liquidated or merged into other funds. Furthermore, only 1,038 (49.3%) both survived and maintained style consistency during the whole period. The especially bad news is that returns used for the active funds excluded the impact of loads. For a fund that charges a 5% load, the five year annualized return would have been about 1% lower. This means that many more of them would have failed to beat their benchmark.

The story does not get any better for actively managed international equity funds, where 70.8% failed to beat their benchmark. This once again belies the often-made claim that indexing does not work for international equities. For real estate funds, 70.2% failed to beat their benchmark. Lastly for fixed income, 81.9% failed to beat their benchmark. It is worth noting that the last five years included the most severe bear market since the Great Depression, so those who claim that active managers add value by avoiding down markets would have a difficult time explaining why the majority failed to beat benchmarks that were 100% invested the entire time.

For those who claim that SPIVA is irrelevant because they will somehow avoid the loser managers, the S&P Persistence Scorecard provides a thorough refutation. Specifically, this report answers the question of whether good relative performance can be expected to persist year after year, which is what we would expect to see if the market were inefficient, opening up the possibility for a select group of managers to be in the upper half or upper quartile of their peer group year after year.

Unfortunately for Manager Pickers, the answer is a resounding no. For example, of the 530 domestic equity funds that landed in the top quartile in the first year of the five-year period, only one stayed in the top quartile in all of the remaining years.

Even when the funds were separated into different size categories, this pitiful result remained unchanged. Of the 1,057 domestic equity funds that landed in the top half in the first year of the five-year period, only 64 stayed in the top half in all of the remaining years. By chance alone, however, there should have been 66!

In other words, the results for manager persistence were worse than what would be expected if all the managers were monkeys throwing darts at the Wall Street Journal.

The odds against successful Manager Picking are daunting indeed. The inescapable conclusion of the Standard & Poor’s reports is that the only way to win the mug’s game of Manager Picking is not to play.