Submitted by Salil Mehta via Statistical Ideas blog,
One would think that active managers would eventually outperform somewhere after the negative press that ensued a year ago. And now that 2015 performance data has been properly audited and tabulated, we can see what the new results are.
We normally don't delve into the same topic twice, but as with some matters there is ample public curiosity to see what might have changed. This is one of those times where is it is critical to revisit our numerous warnings about the skill of active managers in outperforming their benchmarks, particularly now. Over the past year, through today, a number of interesting folks (too many to list here but will do so on social media) at the tip-top of the investment community and in journalism have taken a key interest in the Indomitable benchmarks article. In it we showed that in all 17 mutually-exclusive risky segments of the U.S. markets, active managers underperformed their benchmarks.
The gap was so wild that it was probabilistically a once in a multi-thousand year event due to chance alone. In other words, they were specifically bad for your money, can't blame it on luck, and the government has listened. And the article was one of the most popular ever for this site. Today we take a unique look at the 2015 data recently released by S&P Indices. We scan not just U.S. fund managers, but also examine fund managers in all available countries globally (for both equities, and bonds). The results will only surprise those who have not been paying attention to just about anything, over the past couple years.
And what a gratification it is to see a sole region where fund managers outperformed their benchmark for an asset class! We highlight in green, Italy's equity markets. That's one winner out of the dozen investment segments we looked at. Were all your eggs in Italy over the past decade? Of course they were, since you are the miraculous exception to the rule (consistently above-average just like all money-men think of themselves). For more on how well professionals have performed in predicting the markets, take a look at this important and viral cover story in the Wall Street Journal's MW.
Now for housekeeping we should note that only regions with 10-years of performance data were included, to capture pre-TARP/ZIRP, a full economic cycle, and to not muddle with statistics showing some outperforming by luck over the short-run. Canada was the only exception to the rule, with only 5-years, but their performance was so similar to the U.S. that it was worth showing with this disclaimer. What we notice from this exercise above is that active managers have underperformed (for reasons noted in this popular P&I article) over a long-run not just in U.S. equities, but also across different assets around the world. This includes once-successful investment vehicles such as Berkshire Hathaway, and Sequoia Fund.
Sure there was 1 winner in the dozen mutually-exclusive funds above, while last year's rolling 10-year returns showed 0 winners out of 17 funds. That was the point of this exercise to see what range in underperformance exists across a variety of instruments and cultures (some argue that overseas fund managers may be more quantitative, or disciplined, or play in more inefficient markets, etc.) There is little good of course to report, though not everything appears immensely cruel. We should note that the average underperformance on these 12 funds above is 1% (with a standard deviation of 1% as well), and the 1-year U.S. equity returns for just 2015 was -1.5% (versus a benchmark of +1.0%). So it is clear that the active fund manager results, in developed-market assets around the globe, have continued to underperform by a reasonable amount. And for U.S. equities, the dire contrast on how severely fund managers were underperforming showed through with yet another year where nearly all fund categories underperformed their benchmarks. Enough of an underperformance across most risk segments that it substantiates last year's results in Indomitable benchmarks were not the result of luck.
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As a reminder of what caused this dramatic (and latest) underperformance by the large-cap mutual fund community who are after all paid to outperform the market, here is BofA's explanation why it has become so difficult to outperform the market.
Correlations, dispersion, reversals, positioning…
The recipe for distress may boil down to a few factors. Heightened correlations (Chart 1) and low alpha opportunity (Chart 2) continued to hurt, as stock selection thrives when intra-stock correlations are low and alpha is abundant.
But these contributors to underperformance have been in place for a while - the lit match taken to active returns last quarter was likely the massive reversal – by the market, by sectors, by styles and by stocks - occurring within the quarter. Momentum investors were stymied by the fact almost nothing worked during both halves of the quarter except valuation, a now out of vogue attribute after several years of underperforming. And crowded positions proved particularly damning in the 1Q, with the 10 most crowded stocks underperforming the 10 most neglected stocks by almost 7ppt, an atypically high spread.
With activist central banks having made a mockery of fundamental investing and intervening daily in capital markets either directly or verbally, we don't expect this trend of dramatic active management underperformance to change in the coming months. Which means more active managers angry at passive indexers, which means more "robo advisors", etc.