Do active managers fare better in bear markets? [video]

In this video you'll learn: 

• if active managers fare better in a bear market;
• what the misconceptions are when the stock market falls; and 
• how to manage your risk more cost-effectively. 

Transcript

Robin Powell: It’s well known that actively managed funds performed very badly compared to index funds in the long bull market that ran from March 2009 to March 2020. Some have suggested that because active equity funds have the freedom to hold some cash and bonds, they may perform better in a bear market. But is it true? Dr Tim Edwards is from S&P Dow Jones Indices.

Tim Edwards: So the evidence is unequivocal. The historical record of active funds in bull markets and bear markets is not really distinguished. In strong bull markets, active managers underperform most of the time, in most equity markets in the world. In bear markets, most active funds underperformed most of the time, in most equity markets across the world. However, the one qualifier I will say is the distinction between the potential for outperformance and the reality of outperformance. It is true, and it remains true, that there is the potential to do better by going into cash. The question is whether or not, historically, active managers have managed to do that.

Robin Powell: A common misconception is that to minimise the impact of stock market falls, you need to use an active fund manager. Again, says Dr Edwards, that isn’t true.

Tim Edwards: If you are an investor who wishes to have participation in or a degree of exposure to the equity market, but you are worried about downside risk and you do want to have smoother returns over time, I’ll just make the observation, you don’t necessarily need an active manager to do that. There are things an adviser can do through portfolio construction or even index funds that will achieve those goals for you and often in a more reliable way. Because an active manager actually has to have some degree of timing, they need to know when the market is going to go down in advance, and the evidence tells us that’s really hard to do.

Robin Powell: Simply by the law of averages there will be some actively managed funds that do outperform in a bear market. But typically, the number of funds that do so is consistent with random chance. Even funds with a sizeable holding of cash can underperform the index when markets fall.

Tim Edwards: We did a study a couple of years ago, looking at exactly this point: the volatility of active funds and how it compared to benchmarks. The results of that are as follows: first of all, on average, active funds tend to be a bit riskier than the benchmarks they’re benchmarked against. Part of that could be due to concentration, part of that may be just because they’re looking for more growth and looking to beat the benchmark. So, the record is that they’re a bit more volatile, and when you analyse the returns it looks like a lot of that volatility is coming from higher growth, more risky stocks.

Robin Powell: To summarise, the odds of outperforming the index with an actively managed fund are stacked against you, regardless of market conditions. If you’re worried about the prospect of falling markets, there are cheaper and more effective ways of managing your risk.