Advisor Blog

Jim Cramer, the CNBC pundit of "Mad Money" fame, has declared 2010 to be the "year of active investing."  Even if that's the case, and the historical probability indicates that it won't be, active managers have a lot of work to do to catch up. 

Morningstar recently announced the introduction of a new "Box Score" report that analyzes the performance of actively managed US equity fund managers.  The analysis starts with a universe of 22,000 US equity funds and prunes the list by aggregating multiple share classes and eliminating ETFs, sector funds, bear market funds, long/short funds, and lifecycle funds.  They also exclude funds deemed to have a passive investment approach, including the DFA strategies.  All funds available for purchase at the beginning of any particular time period are included, so the results are free of survivorship bias.  Morningstar compares the results to their own stock indices, which seek to capture the returns of the nine distinct Morningstar style boxes and evaluates performance by calculating both Jensen's alpha and a more comprehensive Fama/French alpha.  The report is similar to the SPIVA report published by Standard & Poors that we've discussed before.

Morningstar finds that 41% of actively managed funds outperformed their respective indices for the three-year period ending June 30, 2009 using Jensen's alpha.  But, Morningstar notes that "once the Fama/French factors are taken into account, active managers' outperformance relative to the indices falls materially."  By the latter measure, only 37% of managers outperformed, and average alpha was negative in all nine style categories.

S&P reports that only 31% of large cap core funds for the five-year period ending June 30, 2009 outperformed the S&P 500 index.  Results were even less favorable for non-US markets, where 13% of the international funds and 10% of the emerging markets funds outperformed their respective benchmarks.  We often hear that non-US stock markets exhibit greater pricing errors than the US, supposedly offering opportunities for clever stock pickers.  The numbers suggest that this is fantasy.

Fixed income markets were no less challenging.  For the same five-year time period, S&P found that 22% of intermediate government funds were outperformers, and the number dropped to 11% for high-yield funds and to only 2% for mortgage-backed securities funds.

Many investors think that active managers can somehow avoid losses in bear markets by carefully selecting superior individual stocks or by shifting out of stocks altogether before market declines occur.  The numbers do not support this view.  In fact, the numbers present compelling evidence that supports the idea that a broadly diversified, passively managed portfolio offers the best path for clients seeking to achieve their investment goals.