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April 28, 2017

Active Funds, Scorecards and the Negative Narrative

by Jake Moeller.

The S&P Dow Jones SPIVA Scorecards are out again. Bunker down the active fund groups, and brace yourselves for the rush of opprobrium you will undoubtedly endure. Be ready for the impending broadside fired by the anti-active brigade targeting your failed objectives and unjustified fee structures.

Active groups turn the other cheek

Indeed, the narrative in financial and social media since the scorecard came out has been unsurprisingly negative. Yet what will we hear from those who are most heinously indicted in this report? Not much, I suspect. There appears to be little appetite for active fund groups to advocate any collective discourse about the potential benefits they offer end investors.

I’ve never really understood this reticence to roll up their sleeves. Perhaps it is diplomacy, perception of collusion, fear of a bout of unfavourable markets, etc. The result, however, is that active fund proponents are increasingly portrayed as mere creatures of faith who in the face of “compelling” evidence waste their hard-earned fee budget on a discredited belief system.

Passive fund flows a larger slice of pie

When you consider European fund flows it is clear investors are voting with their feet. According to Lipper data, in 2015, 32% of net flows into mutual funds were into passive vehicles. For 2016 this was 24% and for 2014 only 7%. Thus when Franklin Templeton or Fidelity announce—as they have—a move into the exchange-traded fund market, it is potentially misconstrued as an ignominious retreat for active rather than the prudent business diversifier it simply is.

Exhibit 1. Estimated net flows into European mutual fund market (€ billion)

Source: Lipper

Passive funds can mean lost opportunities 

The “opportunity cost” of passive investing should be a material consideration for all investors. For example, the best performing active fund over five years to the end of 2016 in the Lipper UK Equity classification outperformed the highest ranked broad-based tracker over the same period by over 110%. That’s considerable outperformance sacrificed to save 50 basis points in costs.

Exhibit 2. The best performing UK equity fund v the best performing broad based tracker in same sector (in GBP) over various time periods

Source: Lipper, Lipper Invesmtment

Persistent outperformance is there to be found 

Choosing that winning active fund was clearly a good move in retrospect, but how do you identify a winner in advance? Rudimentary evidence of persistency can be readily found. Nearly 70% of UK Lipper Fund Award winners over three years for 2014 remained in the first or second quartile of their categories at the end of 2016 for the same period. In the UK Equity classification 62% of funds that had first- or second-quartile one-year performance at the end of 2011 were still there five years later.

Passive industry not to blame for anti-active sentiment

Today, I am considerably more circumspect about the active/passive debate. I’ve seen this late-cycle rush into market-capitalised indices before and know that the tide will turn. Commensurately, I’ve learnt more about the benefits the passive industry provides all investors and commend its innovation. The passive industry itself is not responsible for the pejorative tone that often pervades the debate.

The musings of the proselytising “true believer” are worth little. Active fund groups need to be more willing to provide substantive counterpoints to studies such as the SPIVA scorecards. Then we’d have a much more constructive, balanced, and—for all investors—considerably more valuable narrative to relay.

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This material is provided for as market commentary and for educational purposes only and does not constitute investment research or advice. Refinitiv cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. Please consult with a qualified professional for financial advice.

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