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April 8, 2024

Monday Morning Memo: Performance Review – Relative Performance Equity Funds as of March 31, 2024

by Detlef Glow.

It’s fair to say that the time period between April 1, 2023, and March 31, 2024, was a period in which active fund managers could have shown their asset selection and timing skills since the markets were driven by a number of different factors. Each of these factors could have caused a major market downturn on their own. There were a lot of geopolitical tensions around the globe beside the war in Ukraine, which showed that democratic states are more vulnerable than one may think.

Also, there were economic factors which burdened the expectations of investors, such as China’s failure to meet the growth expectations of investors when its economy was reopened after the end of the country’s zero-COVID strategy. Talking about China, the credit crisis in the Chinese real estate sector later in the year was another factor that could have caused a market downturn if it wasn’t handled well by the Chinese government. Nevertheless, investors are still cautious about investments in China.

After the meltdown in the bond segment during the interest hiking cycle over the course of 2022, investors hoped that the measures taken by central banks would bring down inflation and lead to falling interest rates. This assumption went against the hawkish statements of central banks around the globe for the first 10 months of 2023. The relatively high interest rates raised fears that some major economies such as the U.S. would face a hard landing. In addition to this, some investors might have recalled bad memories when the Silicon Valley Bank and two other regional banks were closed in early March 2023. These feelings might have become worse when Credit Suisse struggled later in the month and was finally taken over by UBS by governmental order.

On the other hand, the spectacular performance of the so-called Magnificent Seven (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla) drove the U.S. markets up. The stellar performance of these stocks might have reminded some investors of the performance of some stocks before the burst of the so-called “dot.com bubble.” As a result, many investors might have been caught between fear and greed when looking at the U.S. equity markets.

That said, some major equity indices reach new all-time-high values over the last 12 months despite all the economic and geopolitical headwinds over the course of the year.

With these facts in mind, the last 12 months can be seen as time period 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, the results of this study show that active equity fund managers did not achieve this goal.

Since this study was conducted over a limited time period, the results have only a limited prediction power for the long-term results of active managers. Nevertheless, studies over different time periods have shown similar patterns.

 

Methodology

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 which have been liquidated or merged during the year, as there is no complete performance history for these products for the analyzed time period. As a result of the last step, this analysis has a survivorship bias, which is in favour of the average results; i.e. the stated average results might be more positive as they would be if all merged and liquidated funds would have been taken into consideration.

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, were able to add value over the course of the analysed time period. 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 product.

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 April 1, 2023, and March 31, 2024. 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 with a plain vanilla global equity investment objective. Funds with a more specific investment objective will receive an individual technical indicator, which is more suitable than the generally assigned plain vanilla index. 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 Versus Their Fund Manager Benchmarks

A look at the overall results of the relative performance of the 14,000 actively managed funds (conventional and ESG-related) versus their fund manager benchmarks shows that active managers failed to deliver added value since 4,964 funds (35.46%) delivered an outperformance, while 9,036 funds (64.54%) were underperforming their respective fund manager benchmarks over the course of the analysed 12 months period. These numbers show that the percentage of outperforming funds has slightly improved compared to the report as December 31, 2023. The overall average relative performance of all equity funds compared to their fund manager benchmarks for the analyzed 12-month period is negative 4.30%, which is worse than in our last report (-2.40%).

This underperformance needs to be seen in the light of the fees and expenses paid by the fund since indices and benchmarks do not include any fees and expenses. The overall TER for all equity funds covered within this study is 1.540%, which means that roughly one-third of the average underperformance can be attributed to fees and expenses.

Graph 1: Percentage of Outperforming and Underperforming Funds (Relative Performance vs Fund Manager Benchmark) between April 1, 2023, and March 31, 2024

Performance Review: Relative Performance of Equity Funds.

Source: LSEG Lipper

One reason for the low percentage of outperforming ESG-related funds can be seen in the fact that a number of ESG-related funds are using conventional benchmarks to showcase their ability to beat the respective market. This approach has been taken as critics raised concerns about a possible underperformance of ESG-related products compared to their conventional peers caused by their exclusion criteria. As for this, a performance comparison against a broad conventional market benchmark seems to make sense to calm down the critics, but it also contains the risk of wrong assumptions in market environments which favor companies/sectors/industries which are not eligible for ESG-related funds.

In more detail, 3,533 (39.06%) conventional funds beat their respective fund manager benchmarks, while 5,513 (60.94%) showed an underperformance over the course of the analysed time period. The disadvantage of actively managed products gets even clearer in the segment of ESG-related funds where only 28.89% (1,431) of the available products showed an outperformance, while 71.11% (3,523) 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) between April 1, 2023, and March 31, 2024 by Management Approach

Source: LSEG 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 the respective margin. The overall average performance of conventional funds between April 1, 2023, and March 31, 2024, was negative 2.04%, while ESG-related showed an on average higher overall underperformance of negative 3.77%. A closer look at the performance pattern shows that outperforming ESG-related funds showed a lower average outperformance (4.95%) compared to their conventional peers (5.53%). The same pattern is true for the average underperformance since ESG-related funds (-7.31%) showed a higher underperformance compared to their conventional peers (-6.89%).

Graph 3: Average Outperformance and Underperformance of Active Managed Funds (Relative Performance vs Fund Manager Benchmark) between April 1, 2023 and March 31, 2024 by Management Approach

Performance Review: Relative Performance of Equity Funds.

Source: LSEG Lipper

These results may indicate that the market environment over the analyzed time period was in favor of conventional funds since companies from some of the so-called old economy sectors showed good returns alongside the “Magnificent Seven.” That said, companies from the old economy sectors are often not as advanced with regard to their ESG credentials and, therefore, are often excluded from ESG-related portfolios. Keeping in mind that a high number of ESG-related funds are using conventional fund manager benchmarks, it can be concluded that the overall success of ESG-related funds compared to their conventional peers is highly dependent on market trends.

  

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 to 24,341 funds and ETFs, we witnessed somewhat the same results for the relative performance of actively managed equity funds versus their technical indicators. This is because 7,636 products (31.37%) were able to outperform their technical indicators. Meanwhile, 16,705 products (68.63%) showed an underperformance. These results are echoing the trend visible in the relative performance vs. the fund manager benchmarks, since the results are also slightly better than those from the previous report. The overall average relative performance of all equity funds compared to their technical indicators for the analyzed time period is negative 7.26%. This average underperformance is worse than in previous report (-3.58%).

Graph 4: Percentage of Outperforming and Underperforming Funds (Relative Performance vs Technical Indicator) between April 1, 2023, and March 31, 2024

Source: LSEG 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 results when comparing the funds with their fund manager benchmarks. The majority of conventional funds (10,693, or 64.93%) showed an underperformance compared to their respective technical indicator, while 5,776, or 35.07%, showed an outperformance. These numbers echoed the slight improvement in the overall numbers. Conversely, the results for ESG-related products were worse compared to the former report, as 76.37% (6,012) of the ESG-related products showed an underperformance, while 23.63% (1,860) showed an outperformance.

Graph 5: Percentage of Outperforming and Underperforming Funds (Relative Performance vs Technical Indicator) between April 1, 2023, and March 31, 2024, by Management Approach

Performance Review: Relative Performance of Equity Funds.

Source: LSEG Lipper

As far as the relative performance versus the technical indicator is concerned, one needs also 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 average out- and 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 fully represent the eligible investment universe of specific funds, especially when they are following an ESG-related investment approach.

The overall average relative performance of conventional funds compared to their technical indicators between April 1, 2023, and March 31, 2024, was negative 3.29%, while ESG-related funds showed on average a higher overall underperformance of negative 5.13%. A more detailed view on the performance pattern shows that ESG-related funds showed on average a slightly lower relative underperformance (-9.14%) compared to their conventional peers (-9.32%). These results reversed for the relative average outperformance since ESG-related products showed a lower outperformance (of +6.50% versus +7.26%) for conventional funds.

Graph 6: Average Outperformance and Underperformance of Actively Managed Funds (Relative Performance vs Technical Indicator) between April 1, 2023, and March 31, 2024, by Management Approach

Source: LSEG Lipper

Since the relative performance of actively managed funds versus their technical indicators were somewhat in line with the results shown relative to their fund manager benchmarks, it can be concluded that actively managed funds were on average not able to deliver value added for investors over the course of the analyzed time period.

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 relative performance achieved with the individual investment objective of a fund, as the fund may have different constraints on selection of single securities which are not reflected in the technical indicator.

From my perspective, the Achilles heel of the asset management industry is the way the risk management process works. Most asset managers measure the risk of their portfolios relative to their benchmark or index. As a consequence, the asset allocation decisions of portfolio managers are restricted by the weighting of the stock, sector, region, or country within the respective benchmark. This means that a portfolio manager might not be able to avoid an investment in a stock or sector which he/she expect to underperform.

In addition, a high number of asset managers evaluate the performance of the fund relative to its benchmark, resulting in the fact that a negative performance of the fund is seen 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 to market events 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 topic for another discussion.

 

The views expressed are the views of the author and not necessarily those of LSEG.

This material is provided as market commentary and for educational purposes only and does not constitute investment research or advice. LSEG Lipper 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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