A new study finds few funds outperform their benchmarks on a risk-adjusted basis
In the face of evidence showing how index-based funds deliver better returns than their active counterparts on an after-fee basis, financial advisors and active fund advocates often argue that stock-picking managers shine when risk is taken into account. But the latest S&P Indices Versus Active (SPIVA) report from S&P Dow Jones Indices (SPDJI) certainly doesn’t help their cause.
The report, released weeks after SPDJI’s unflattering assessment of Canadian mutual fund performance in 2018, focused on “whether actively managed funds are better at risk management than passive indices.” That alludes to an often-cited criticism of passive funds, which argues “that indices are not risk-managed, unlike active management” — which means active funds should do better in down markets.
To test that theory, the performance of funds over five-, 10-, and 15-year periods was compared to the returns of benchmarks that were appropriate to managers’ investment styles (for example, large-cap value funds were compared not to the S&P 500 Index, but to the S&P 500 Value Index). Risk, meanwhile, was computed as the standard deviation of monthly returns over a given period. Risk-adjusted returns were derived based on the Sharpe ratios of the funds.
“To make our comparison relevant, we also adjusted the returns of the benchmarks used in our analysis by their volatility,” the report said.
It also acknowledged measures of risk other than the Sharpe ratio that may also be of interest to market participants, such as the downside variance or Sortino ratio, but added that those measures are suitable for strategies with positively or negatively skewed returns, such as options-based or CTA strategies.
“Since our study universe comprised long-only, 40 Act mutual funds, and for purposes of simplicity and comprehensiveness, we chose the Sharpe ratio to represent risk-adjusted returns,” the report said.
The study drew data from the University of Chicago’s Center for Research in Security Prices (CRSP) Survivorship-Bias-Free US Mutual Fund Database. Looking at US equity, international equity, and bond funds all based in the US that span multiple categories, SPDJI found that save for a few exceptions, actively managed funds generally underperformed their index benchmarks despite typically having higher risk exposure.
Both US and international equity funds failed to outperform their benchmarks on a risk-adjusted basis; across almost all US equity categories, 80% to 99% of funds lagged their benchmarks after fees and on a risk-adjusted return over five-, 10-, and 15-year periods.
US real-estate funds did comparatively better, as 65% to 78% underperformed on a risk-adjusted basis over the same three time frames, after fees. Active international and global funds, including emerging-market funds, underperformed their benchmarks roughly 66% to 93% of the time over the three periods net of fees, making them relatively better than US equity funds.
Active bond funds had even better benchmark-beating records than equity funds, but mostly on a gross-of-fee basis; net of fees, only investment-grade long funds and loan participation funds outdid their benchmarks over five- and 10-year periods.
“[W]e did not see evidence that actively managed funds were better risk-managed than passive indices,” the report said.