Despite the odds, active managers turned in a better-than-expected performance in 2023, according to a report out today by S & P Global. That’s the good news. The bad news: the long-term performance of active managers remained dismal. The SPIVA U.S. Scorecard, run by S & P Global, is the gold standard for evaluating the performance of active fund managers against their benchmarks. The 2023 report includes more than 2,000 mutual funds and ETFs in the U.S., substantially all the domestic funds in the U.S. The majority (60%) of large-cap fund managers underperformed the S & P 500 in 2023, according to S & P Global. While that may not seem like an impressive performance, it is slightly better than the historic average of 64% that underperform the S & P 500. Anu Ganti, S & P Global’s U.S. head of index investment strategy and the lead author of the report, said the relative outperformance was “surprising.” Surprising, because 2023 was a tough year for active managers. Beating the stock market is a very difficult game. Stock pickers tend to do better during periods when: 1) there is high volatility, 2) markets are trending down, and 3) megacaps are underperforming. This is what happened in 2022, and in that year only 51% of large-cap managers underperformed the S & P 500, which was the best year for large-cap active equity performance since 2009. Last year, however, was the opposite: low volatility, strong market performance (S & P 500 up 26% on a total return basis) and a significant outperformance from mega-cap technology stocks on the back of the artificial intelligence story. Active fund managers tend to have a tough time when a small group of stocks lead the market. Why? The game for active managers is to outperform the market. When a small group of stocks lead, active managers would have to pick those exact few stocks that outperformed â and have an even higher concentration in them to outperform. But it is difficult (almost impossible) to consistently pick those few winners and, at any rate, active managers are usually reluctant to take such concentrated bets. The broadening of the market in the last two months of the year was likely a major factor in improving the performance of active managers. “Sixty percent underperforming is a relatively benign result, given the outperformance of megacap stocks last year,” Ganti said. Terrible long-term track records S & P has been doing this study for 23 years. The key finding: underperformance rates go up as the time horizon gets longer. For example, for large cap funds, 60% underperform after one year, 79% underperform after five years, 87% underperform after 10 years, and 94% underperform after 20 years. Track record of large-cap fund managers (% who underperform S & P 500) After 1 year: 60% After 5 years: 79% After 10 years: 87% After 20 years: 94% Source: S & P Global Similar results are seen when looking at mid-cap and small-cap funds. The picture’s no better for fixed income active managers long term: Track record of active fixed-income managers (% of general investment-grade fixed income funds that underperform their benchmark) After 1 year: 98% After 5 years: 87% After 10 years: 93% After 15 years: 95% Source: S & P Global This is a dismal record. Surveying the results, the 2019 SPIVA study concluded, “[T]he persistence of fund performance was worse than would be expected from luck.” Worse than would be expected from luck. An important point about the SPIVA study: it accounts for both fees and survivorship bias. Many funds liquidate or merge over time. Over a ten-year period, about one-third of funds go out of business, largely due to poor performance, but the SPIVA report accounts for those funds. Active management outperformance is getting harder What does this all mean for an average investor? If I have a portfolio of index funds, is there a reason to add active funds too? The problems active managers confront are not temporary. They do not underperform because they are dumb. Quite the contrary: the quality of active managers has never been higher. They are smart and getting smarter, and that is part of the problem. Ganti identified three consistent problems active managers encounter: 1) The market is largely professionalized; investors, whether professional or retail, do not have an information advantage; 2) Active managers’ fees are higher than index fund fees; 3) In any given year, only a minority of stocks typically outperform the markets, and it is difficult (almost impossible) to select what stocks will outperform. “Given that the market is largely professionals, active management fees are higher and index investors are achieving significant savings, and active managers have a very difficult time picking stocks that outperform, the game is only going to get harder for active management,” Ganti said. Why not just find the needle in the haystack? If 90% of active managers underperform the market over time, why not just take the 10% that do outperform? Answer: good luck finding those 10%. “Persistence in stock picking is fleeting,” Ganti said. It is very difficult for those in the top to consistently outperform. A fund that outperforms over, say, a 10-year period is unlikely to be the same fund that outperforms in the next 10 years. There is also a very big difference between luck and skill. The data shows that a good part of the reason that 10% outperform is luck, and that is very different from skill. “Outperforming the stock market is difficult,” Ganti told me. “Outperforming the stock market consistently over many years is even harder.”
