by Detlef Glow.
It’s fair to say that 2020 was a year like no investor has experienced before, even looking back to the Great Depression or World Wars I and II. The year began with fears of a possible war between North Korea and the U.S., an upcoming trade war between the U.S. and China, and a possible hard Brexit. In a normal year, these geopolitical tensions would have put enough pressure on the markets to cause a major downturn. But in mid-February, the coronavirus, which had previously been seen as a local problem in China, was detected in an increasing number of countries around the world and eventually caused the COVID-19 pandemic.
Governments around the globe closed their borders, their economies, and their societies to prevent the spread of the virus. These lockdowns led to a major downturn in the equity markets in March and an additional sell-off in other liquid assets as investors wanted to protect their money. Within these market conditions, the price for oil fell below zero for the first time in history.
That said, the governments have not only introduced lockdowns, they have also launched fiscal stimulus packages to support companies and residents and to cushion the expected economic downturn. In addition to these relief packages, central banks around the globe have resumed or increased their quantitative easing programs to maintain liquidity in the markets. Altogether, the amounts spent on all the relief packages from the various institutions globally reached a level that has never been witnessed before.
As a result of the actions taken by governments and central banks, the markets returned to generally normal patterns. Moreover, these measures also helped when the second wave of COVID-19 arrived in autumn, as investors felt confident enough to stay in risky assets. This behaviour drove equity markets around the globe to new all-time highs.
With these facts in mind, 2020 can be seen as a year in which active asset managers had the chance to deliver a high value added compared to passive strategies by using cash as a risk buffer in times of market turmoil and investing in high beta stocks in an upswing of the market. In general, active fund managers of equities funds did not achieve this goal during the market downturn in the first quarter of 2020, as 55.40% of the funds underperformed their technical market indicator. Nevertheless, we observed greater resilience to losses among funds that followed an ESG-related investment strategy during this time period. Please read the study: Are ESG Funds Outperformers During the Corona Crisis? for more detailed information about this.
Since that study was conducted over a limited time period and is based only on the relative performance of funds against the technical indicators assigned by Lipper, and not against the fund manager benchmark, the results of the study might not be seen as representative. Therefore, we conducted a new analysis of the relative performance of equity funds against their technical indicators and fund manager benchmarks over the full year 2020.
The analyzed fund universe has been derived from all mutual funds and ETFs listed in the Lipper database, with the asset type equity assigned. From this universe we excluded all passive products, as well as all convenience share classes, and all leveraged products. We also excluded all funds launched after December 31, 2019, as there is no complete performance history for these products for the analyzed time period.
Passive funds were excluded from this comparison, as the aim of the analysis is to show whether actively managed funds in general and ESG-related products in particular, can add value over the course of 2020. In this regard, the inclusion of passive products would have skewed the results, since the expected return of a passive product is the return of the index minus the total expense ratio of the respective fund.
These measures brought the available fund universe to 22,356 conventional (non-ESG) and 2,903 ESG-related equity funds.
We used the fund manager benchmark and in a second analysis the technical indicator as reference to calculate the relative performance of the respective actively managed funds between January 1, 2020, and December 31, 2020. A closer look at the number of funds in each analysis shows that it is worth conducting a second analysis, as a large number of funds do not disclose their benchmarks or use a benchmark that is not available in the Lipper database. Since the analysis includes funds from all parts of the world, the base currency for all calculations is the U.S. dollar.
Since not all funds have or disclose a benchmark, Lipper has assigned standard market benchmarks as technical indicators for all Lipper Global Classifications which allow relative calculations to be performed even when the fund manager benchmark is missing. One example of this is the Lipper Global Classification (LGC) Equity Global where we assigned the MSCI Global TR USD as technical indicator for all funds. Although a technical indicator is quite helpful for the analysis of a complete peer group, it has some flaws, as the respective benchmark may not represent all restrictions applied on the fund level. This is especially true with regard to ESG/SRI funds since a standard market benchmark does not take any ESG/SRI criteria into consideration and may have, therefore, a deviant asset allocation at country and sector level compared to the respective fund.
Results: Relative Performance of Actively Managed Funds vs Their Fund Manager Benchmarks
A look at the overall results of the relative performance of the 14,801 actively managed funds (conventional and ESG-related) versus their fund manager benchmarks shows that active managers have delivered added value, since 7,574 funds (51.17%) delivered an outperformance, while 7,227 (48.83%) were underperforming their respective fund manager benchmarks.
Graph 1: Percentage of Outperforming and Underperforming Funds (Relative Performance vs Fund Manager Benchmark)
Source: Refinitiv Lipper
In more detail, 6,486 (50.29%) conventional funds beat their respective fund manager benchmarks, while 6,412 (49.71%) showed an underperformance over the course of the year 2020. The advantage of actively managed products gets even clearer in the segment of ESG-related funds where 57.17% (1,088) of the available products showed an outperformance, while 42.83% (815) of funds showed an underperformance compared to their respective fund manager benchmarks.
Graph 2: Percentage of Outperforming and Underperforming Funds (Relative Performance vs Fund Manager Benchmarks) by Management Approach
Source: Refinitiv Lipper
To evaluate the success of actively managed funds, it is not enough to count the funds which have outperformed or underperformed their respective fund manager benchmarks. It is also important to analyze at which margin. The overall average outperformance of conventional funds between January 1, 2020, and December 31, 2020, was 2.15%, while ESG-related showed an on average higher overall outperformance of 3.78%. A closer look at the performance pattern shows that ESG-related did not only show a better average outperformance (11.75%) compared to their conventional peers (11.45%), they also showed a lower underperformance (-6.83% versus -7.25% for conventional funds).
Graph 3: Average Outperformance and Underperformance of Active Managed Funds (Relative Performance vs Fund Manager Benchmark) by Management Approach
Source: Refinitiv Lipper
These results may indicate that actively managed ESG-related funds are able to deliver better results than their conventional peers as they showed a higher percentage of outperforming funds, a better average outperformance, and a lower underperformance over the course of 2020.
Results: Relative Performance of Actively Managed Funds Versus Their Technical Indicators
The usage of the technical indicator led to a larger universe of funds for this analysis. But even as the fund universe grew by more than 10,000 products, we witnessed somewhat the same results for the relative performance of actively managed equity funds versus their technical indicators, since 12,780 products (50.88%) were able to outperform their technical indicators. Meanwhile, 12,336 products (49.12%) showed an underperformance.
Graph 4: Percentage of Outperforming and Underperforming Funds (Relative Performance vs Technical Indicator)
Source: Refinitiv Lipper
A closer look at the details shows that the underlying pattern of the ratio between outperforming and underperforming funds relative to their technical indicators is different. This is because the majority of conventional funds (11,161 or 50.20%) showed an underperformance compared to their respective fund manager benchmarks, while 11,071, or 49.80%, showed an outperformance. Conversely, 59.26% (1,709) of the ESG-related products showed an outperformance, while 40.74% (1,175) showed an underperformance.
Graph 5: Percentage of Outperforming and Underperforming Funds (Relative Performance vs Technical Indicator) by Management Approach
Source: Refinitiv Lipper
As far as the relative performance versus the fund manager benchmark is concerned, one needs to evaluate the level of outperformance and underperformance to evaluate the success of the respective funds versus their technical indicators. In general, it can be said that the gap between the highest outperformance and largest underperformance has widened as the universe of analyzed funds has increased. This increase might be caused by the fact that the technical indicator is not always a suitable benchmark for performance comparisons, as it may not represent the eligible investment universe of specific funds.
The overall average outperformance of conventional funds between January 1, 2020, and December 31, 2020, was 1.44%, while ESG-related funds again showed on average a higher overall outperformance of 3.51%. A more detailed view on the performance pattern unveils that ESG-related funds again showed a better average outperformance (12.34%) compared to their conventional peers (11.89%). To the contrary of the results in comparison to the fund manager benchmarks, they showed a greater underperformance (-9.34% versus -8.93%) for conventional funds.
Graph 6: Average Outperformance and Underperformance of Actively Managed Funds (Relative Performance vs Technical Indicator) by Management Approach
Source: Refinitiv Lipper
Although the relative performance of actively managed funds versus their technical indicators differ somewhat from results shown relative to their fund manager benchmarks. Therefore, it can be concluded that actively managed funds have delivered a value added over the course of 2020 and that ESG-related funds are able to deliver better results than their conventional peers. It should be noted that while the use of a technical indicator is a valid comparison to evaluate the performance of a fund compared to the broad market, it has only limited explanatory power with regard to the performance achieved relative to the individual investment objective of a fund.
In addition, one could conclude that ESG-related funds may have a better resilience during rough market periods and can deliver a higher outperformance compared to conventional funds. While I generally agree with this statement, one needs to bear in mind that 2020 was an exceptional year, which makes it hard to compare the results for 2020 with a blueprint from other years. Some of the factors that might have influenced the performance of conventional and ESG-related products might have been single events or can change immediately from one side to the other. One example of this can be seen in the drop of the price of oil, which has massively impacted some conventional funds, while ESG-related funds would normally not invest in fossil fuels. Another performance driver was the general trend toward growth stocks from the new economy. This might have also favored ESG-related strategies since a number of these stocks are also the favorites of ESG investors because these companies do often show a better ESG performance than industrials or other companies from the old economy. Therefore, at least some parts of the superior performance of ESG-related funds must be attributed to market circumstances. In other words, once investors start to favor value stocks, which are often found in sectors known for their high consumption of fossil energies, the performance pendulum may swing back to non-ESG-related funds.
Since resilience to market downturns is one of the key drivers for the success of an investment strategy, it is still not clear if ESG-related strategies are superior compared to conventional investment strategies. However, it has been proven that some measures on the governance of companies can reduce the overall risk of defaults in a portfolio. But these measures are not exclusive to ESG-related strategies.
From my perspective, the Achilles heel of risk management in all kinds of strategies can be seen in the measurement of risk. Most asset managers measure the risk of their portfolios relative to their benchmark or index, which means they will evaluate a negative performance as a success as long as the negative returns are better than those of the respective index or benchmark. Conversely, most investors see negative returns in general as bad results. Therefore, it would make sense that asset managers would implement some risk measures with regards to the absolute performance of their funds to align the interest of investors with the targets of the portfolio managers. Taking the absolute performance into consideration would also help to increase the resilience of a fund since the portfolio manager could use cash as a risk buffer. I certainly know that this is a much-debated topic and that there are different views on this topic in the investment industry. Therefore, I will leave this for another discussion.
Refinitiv Lipper delivers data on more than 330,000 collective investments in 113 countries. Find out more.
The views expressed are the views of the author and not necessarily those of Refinitiv. This material is provided 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.