How Actively Managed Mutual Funds are Scoring

Earlier this month, S&P Dow Jones Indices released their semi-annual report on mutual funds which compares actively managed funds to index funds.  It’s called the SPIVA report, which stands for S&P Index vs. Active management, and the results, once again, don’t bode well for actively managed mutual funds.  I’ve never been a big fan of managed mutual funds because I think the cards are stacked against managers virtually ensuring they’ll underperform their benchmark index over the long haul.

The three main reasons for this are the expenses they need to overcome, forced selling as retail investors sell out of the fund after down periods which locks in losses, and career risk.  I find the third point to be the most interesting.  Mutual fund managers face an asymmetric risk in that they’re not rewarded very well for outperforming a benchmark but they could lose their job if they underperform by a lot.  This leads many managers to invest the fund very closely to their benchmark so returns are in the same ballpark, and they overweight a handful of their top investment ideas in the hope that it will push the fund to finish just ahead of the index.  However, this does not provide enough of a difference from the index to overcome the annual fees and expenses leading most funds to underperform.  The SPIVA report provides the evidence each and every year.

As of June 30, 2014, about 60% of all US large cap stock funds underperformed the S&P 500 Index over the last year, nearly 85% underperformed over the trailing 3 years, and almost 87% underperformed over the last 5 years!

The numbers for US small cap stock funds are even worse with nearly 73% underperforming the S&P Small Cap 600 Index over the last year, 91.5% over the last 3 years and nearly 88% over the last 5 years!

International stock managers have fared a little better but most categories are still seeing 60% to 75% underperformance.  It turns out that bond fund managers tend to score best against the indexes, although each category has been pretty hit or miss.

You can find the full report here.

So what does this mean for investors?  If you’re a do-it-yourselfer and you have the time to do the proper research, I believe individual stocks are best.  Otherwise, just stick to index funds.  They’re far simpler, often more tax efficient, and will outperform the large majority of actively managed mutual funds over the long haul.

Thanks for following!

-Nick

Like what you see here?  It’s easy to subscribe using the box in the top-right or share this post with friends using the buttons below.