Active managers have been struggling for years to outperform their benchmarks.
According to the S&P Dow Jones Indices SPIVA U.S. ScorecardAccording to the S&P Dow Jones Indices SPIVA U.S. Scorecard (PDF), for the one-year period ended June 30 of this year, 84.62% of large-cap managers, 87.89% of mid-cap managers, and 88.77% of small-cap managers underperformed the S&P 500, S&P 400 and S&P SmallCap 600 benchmarks, respectively.
Results for five and 10 year periods are also disappointing. Investors have taken notice. During the first six months of this year, $500 billion has been allocated from active funds to passive funds, according to a recent article from Bloomberg.
Unfortunately for stock pickers, the six-month period isn’t an exception, with investors having yanked assets from actively managed funds in favor of passive products every year since 2011.
Active managers, not surprisingly, have launched a full-court press to convince investors that stock picking still makes sense. Invesco is just one example. It has published white papers such as “Why invest in average?” and “Think active can’t outperform? Think again.”
The firm’s papers seek to dispel beliefs such as benchmarks follow sound investment strategies, benchmarks offer steady performance and less risk, and benchmarks always outperform active strategies. The firm maintains that active management goes through cyclical periods of outperformance and that different styles of active management can outperform at different times. Invesco also maintains that high conviction investing, rather than benchmark hugging, has a compelling track record.
The Neuberger Berman Small Cap Value Team, in a Seeking Alpha column, also addresses the cyclical nature of active outperformance. The team explains that small cap managers tend to avoid risker equities when the Federal Reserve is easing monetary policy and therefore underperform during those periods. When the Fed tightens, however, active small-cap pickers outperform.
The Capital Group has also devoted considerable resources to fending off competition from passive funds. Its paper, “Don’t Settle for Average,” breaks down the firm’s track record of outperformance and maintains that the firm’s funds have consistently added value and have outperformed in many market cycles. The firm maintains that concluding that outperformance is impossible is similar to deciding that if an average person can’t dunk a basketball, then no one can. The firm also touts its low fees as an advantage when it comes to outperformance.
Active managers appear to have John Plender, a Financial Times columnist, as an advocate. In a recent column, he maintains that index investing is risky.
The PowerShares Nasdaq 100 ETF, which is one of the 10 largest ETFs in the U.S., is an example. Approximately 41% of the index is represented by Apple, Google, Microsoft, Amazon, and Facebook. Active managers who take on that kind of risk would probably be considered reckless, he maintains.
Despite the considerable efforts of active managers to stem the popularity of active funds, investors have been flocking to index products, as illustrated by fund flow data for the first six months of this year.
Conditions may be changing and those conditions may have little to do with actions taken by active managers. More specifically, the tide appears to have changed for active management.
During the first six months of this year, 54% of stock pickers outperformed the Russell 1000 index and, if the trend continues, this could be the best year for active stock managers since 2007, according to the Business Insider and Bank of America.
Active managers tend to favor information technology, consumer discretionary, and health care sectors. Those sectors have outperformed this year, which has been a strong tailwind for stock pickers. If the trend continues, it’s likely that investors that are famous for chasing returns may reverse their preference for passive funds and flock back to actively managed portfolios.