by Detlef Glow.
Rough market conditions such as those we have over the course of H1 2022 can be seen as the perfect litmus test for active managers, as such challenging periods offer a lot of opportunities for active equity fund managers to show their capabilities with regard to risk reduction and market timing.
But have active equity fund managers in general outperformed their benchmarks or were they not able to add value for their investors? Even as this question does sound somewhat polemic, it goes much further as a number of market participants and observers see an underperformance of actively managed products, especially during rough market conditions, as one of the reasons for the success of ETFs and other passive investment vehicles.
Another dimension of this discussion involves comparing the results from ESG-related actively managed funds to those of products which do not incorporate ESG credentials at all, since some investors see the integration of ESG measures as an additional layer to reduce the overall risk within the portfolio.
The analyzed fund universe has been derived from all actively managed mutual funds listed in the Lipper database, with the asset type equity assigned. From this universe we excluded all passive products (index-tracking mutual funds), as well as all convenience share classes, and all leveraged products. We also excluded all funds launched after December 31, 2021, as there is no complete performance history for these products for the analyzed time period.
In addition to this we also exclude all funds from the Lipper global classifications Equity Emerging Europe and Equity Russia, as the valuations from those products may differ widely from the developments of the markets since all trading of Russian stocks have been stopped by the sanctions initiated in response to the war in Ukraine.
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 rough market period that we witnessed over the course of 2022 year to date. 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 24,207 conventional (non-ESG) and 7,022 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, 2022, and June 30, 2022. A closer look at the number of funds in each analysis shows that it is worth conducting a second analysis since 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 since 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 the country and sector level compared to the respective fund.
Results: Relative Performance of Actively Managed Equity Funds vs Their Fund Manager Benchmarks
A look at the overall results of the relative performance of the 17,930 actively managed funds (conventional and ESG-related) versus their fund manager benchmarks shows that active managers have not delivered added value—only 6,901 funds (38.49%) delivered an outperformance, while 11,029 (61.51%) 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, 5,558 (40.97%) conventional funds beat their respective fund manager benchmarks, while 8,008 (59.03%) showed an underperformance over the course of the first half of 2022. The struggle of actively managed products to beat their fund manager benchmarks gets even clearer in the segment of ESG-related funds where only 30.77% (1,343) of the available products showed an outperformance over the course of 2022, while 69.23% (3,021) of the 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 performance of conventional funds between January 1, 2022, and June 30, 2022, was negative 2.52%, while ESG-related products showed an on average lower overall performance of negative 4.29%.
A closer look at the performance pattern shows that ESG-related products showed a lower average outperformance (3.92%) compared to their conventional peers (4.07%), but they did better as far as the average underperformance (-5.57% versus -7.10% for conventional funds).
This means that ESG-related products offered their investors a lower downside performance than their conventional peers, which can be seen as an advantage for these ESG-related products compared to their conventional peers.
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 not able to deliver better results than their conventional peers as they showed a lower percentage of outperforming funds, a lower average outperformance, and a lower overall average performance over the course of 2022 so far.
Looking at these results, one needs to bear in mind that these statistics change over time. Therefore, it might be noteworthy that these results were in favor of ESG-related products over the course of 2020 and showed a mixed picture in 2021.
Results: Relative Performance of Actively Managed Equity 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 13,000 products to 31,229 funds, we witnessed somewhat the same results for the relative performance of actively managed equity funds versus their technical indicators, since only 11,591 products (37.12%) were able to outperform their technical indicators. Meanwhile, 19,638 products (62.88%) 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 somewhat in line with the results versus the respective fund manager benchmarks. The majority of conventional funds (14,527 or 60.01%) showed an underperformance compared to the respective technical indicator of their peer group, while only 9,680, or 39.99%, showed an outperformance. On the other hand, 72.79% (1,911) of the ESG-related products showed an outperformance, while 72.79% (5,111) 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 technical indicator is concerned, one needs to evaluate the level of outperformance and underperformance to evaluate the success of the respective funds.
In general, it can be said that the gap between the highest outperformance and largest underperformance has closed even as the universe of analyzed funds has increased. This pattern 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 a specific fund.
The overall average performance of conventional funds between December 31, 2021, and June 30, 2022, was negative 2.19%. Compared to this, ESG-related funds showed an on average lower overall performance of negative 3.79%.
A more detailed view on the performance pattern unveils that ESG-related funds showed a lower average outperformance (4.81%) compared to their conventional peers (5.89%). In line with the results in comparison to the fund manager benchmarks, ESG-related products showed a lower underperformance (-7.00% versus -7.59%) for conventional funds.
Graph 6: Average Outperformance and Underperformance of Actively Managed Funds (Relative Performance vs Technical Indicator) by Management Approach
Source: Refinitiv Lipper
These results may foster the active vs passive discussion, since one could conclude that the active managers didn’t reach their goals and can therefore be replaced by passive products. With regard to this assumption, one needs to bear in mind that most active managers have long-term performance targets rather than short-term targets.
As the results with regard to the relative performance of actively managed funds versus their technical indicators is somewhat in line with the results shown relative to their fund manager benchmarks, it can be concluded that both methods to analyze the universe of equity funds can be seen as valid. Nevertheless, investors should keep in mind that while the use of a technical indicator seems to be 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.
By looking at the overall results, one could conclude that ESG-related funds have a better resilience (lower average underperformance) during rough market periods, but they are not able to deliver a higher overall average performance compared to conventional funds. This finding backs the thesis that ESG strategies might be able to reduce the overall relative downside risk. With regard to this assumption, one needs to bear in mind that a pure performance measure is not the right measure to evaluate the overall success of the fund manager, as this is measured with risk-adjusted returns.
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 over longer time periods. 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 regard 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.
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The views expressed are the views of the author and not necessarily those of Refinitiv or LSEG.
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.