Vanguard founder John Bogle’s “cost matters hypothesis” explains why, after subtracting fees, returns from active management tend to be smaller than returns from passive management, as the latter costs less. However, retail investors tend to pay higher advisory and management fees than institutional investors.
Since 2002, S&P Dow Jones Indices has been publishing its S&P Indices Versus Active (SPIVA) U.S. Scorecard. The scorecard measures the performance of actively managed equity funds investing in domestic and international stocks, as well as active fixed-income funds, against their respective benchmarks.
SPIVA Weighs In
For the first time, the 2016 SPIVA Institutional Scorecard examined the impact of fees on the performance of mutual funds and institutional managed accounts against their appropriate benchmarks. The report, which analyzes actively managed funds across equity and fixed-income categories using gross- and net-of-fees returns, covered the 10-year period ending in 2016.
Following is a summary of its key findings:
The findings from the SPIVA scorecard are consistent with those of Joseph Gerakos, Juhani Linnainmaa and Adair Morse in their December 2016 study, “Asset Managers: Institutional Performance and Smart Betas.” They studied the performance of delegated institutional asset managers with $18 trillion in annual average assets under management over the period 2000 through 2012—close to 30% of worldwide investable assets.
They found that on a risk-adjusted basis (accounting for exposure to common factors), the net excess return of institutional managers in U.S. equities was -1.16% with a t-stat of 2.60. For global equities, institutional managers’ net excess return was -1.69% with a t-stat of 2.29. However, the authors also found that the net alphas were positive for U.S. fixed income (0.17%) and global fixed income (0.58%), although statistically insignificant at even the 10% level in both cases (with t-stats of 0.45 and 0.91, respectively).
Even with the advantage of asset management consultants (the majority of institutional investors engage consultants such as Russell, SEI and Goldman Sachs) and the added benefit of incurring lower fees than retail investors, institutional investors failed to outperform appropriate risk-adjusted benchmarks. Additionally, the implementation costs of passive strategies such as index funds, ETFs and types of structured portfolios, continue to fall, creating even greater hurdles for active management.
As Yogi Berra would say, reading the annual SPIVA scorecards is like deja vu all over again. They also explain why the trend toward passive investing and away from active investing is so strong. There is one thing stronger than all the marketing machines of Wall Street and, to paraphrase author Victor Hugo, that is an idea whose time has come. The bottom line is that whether you’re an institutional or a retail investor, active management is the loser’s game.
This commentary originally appeared August 11 on ETF.com
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