Very few active funds outperform in the long run

Robin Powell of the Evidenced Based Investor & Tim Edwards of S&P Dow Jones Indices share some insights on active funds performance

RP: Investors choose actively managed funds in the hope that they will beat the market.

The problem is that, in the long-term, very few active funds actually do so.

S&P Dow Jones Indices has tracked active fund performance in the US for more than 20 years.

TE: Over the past two decades, it’s been rather hard to beat the benchmark – specifically and especially in large-cap equities, and especially US large-cap equities. A grand total of 95% of US large-cap actively managed equity funds underperform the S&P 500.

RP: The UK stock market is the most heavily researched stock market in the world.

It’s sometimes suggested that lesser researched markets — emerging markets, for example — offer better opportunities for active investors.

But is it true?

TE: I hear on many occasions that emerging markets – because they are less well-resourced and less well covered by analysts, there’s more opportunity to add insight – I often hear that one would expect a better outperformance rate from active managers in emerging rate. But, in fact, the opposite is the case. Our data suggests that emerging markets are actually one of the hardest markets to outperform the benchmark.

RP: One of the reasons why S&P’s research can be trusted is that, unlike other studies, it takes into account survivorship bias.

Never mind outperforming, most actively managed funds find it a struggle simply to survive.

TE: If you have an actively managed fund – a hypothetical one – and, if it doesn’t do very well – if it’s sort of underperforming the benchmark and it underperforms again the next year and again the next year – what tends to happen is that it’s not a very popular strategy. So it tends not to attract many assets and what very often happens to underperforming funds is they are often liquidated by the fund provider or they’re merged into another fund. That means the funds we are looking at that are alive today have a bias in them. They’re the ones – not always, but typically – but they’re the ones that outperform.

RP: Of course, it is still possible that you will manage to pick one of the very few funds that will outperform in the long run. But the odds are heavily stacked against you.