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Many investors pay a fund manager to buy and sell their stocks at the right time using actively managed funds

In this video you'll learn:

  • why most investors use actively managed funds;
  • how SPIVA shows that most active managers underperform most of the time; and
  • why your portfolio should be passively managed.

 

Transcript

Robin Powell: Most investors use actively managed funds. In other words, they, pay a fund manager to buy and sell the right stocks at the right time. But, in general, how well do active funds perform? S&P Dow Jones Indices keeps a running scorecard called SPIVA.

Craig Lazarra: SPIVA stands for S&P Index versus Active. It’s a study that we’ve done for the last fifteen years in the US and then have expanded globally. The point of SPIVA is to compare the returns of actively managed portfolios to indexes that are appropriate for their style of management. So, for example, we compare large-cap US funds to the S&P 500, small-cap funds to the S&P Small-Cap 600 and so forth. So, it’s a way of understanding whether active managers are adding value relative to a good passive alternative, or the best passive alternative for their style of management. What we find constantly with SPIVA, both in the US and internationally as we’ve expanded it, is that the answer to that question is, that they don’t.

Robin Powell: Worryingly for investors, SPIVA shows that most active managers underperform most of the time. What’s more, even those funds that do outperform rarely do so for long.

Craig Lazarra: We look back, say five years, and say, let’s identify all the large-cap equity managers who were above-average, five years ago, and then ask the question: "Of those who were above average five years ago, how many were above average four years ago, three years, two years, one year and so forth?" The probability of flipping a coin and getting four heads in a row is 6,25%. So, if, in fact, they were skilled, in that database of above-average managers from 5 years ago, you would expect that more than 6,25% would be above-average in every subsequent year. And it’s not, typically the result is in the 4-5% range.

Robin Powell: So, are there any signs that active fund performance is improving? In recent years, the answer is a definite No. In fact, it appears to be getting worse. The reason for that may have something to do with the so-called paradox of skill.

Craig Lazarra: In any human activity success is partly a factor of skill and partly a factor of luck. The paradox of skill says, that as the absolute level of skill goes up over time, the importance of luck to the result is more important. And in the investment context, what that says is, and I could testify from my own experience, the average investment manager today is far more skillful than he was thirty years ago. He’s better informed, better educated, our knowledge of financial theory has improved, therefore the average level of theoretical knowledge has improved, he has access to big data and analytics etc.. All of that means, the average manager is much better today than he was thirty years ago. Unfortunately, form the clients' standpoint, it doesn’t matter, because the average manager is competing not against somebody from third years ago, he’s competing against his contemporary today, who’s just as skillful as he is. Hence, the relative importance of luck, rather than skill.

Robin Powell: So, it’s not that active managers are unskilled — in fact quite the opposite. There are also too many of them competing with one another. The lesson from SPIVA, therefore, is that all, or at least most, of your portfolio, should be passively managed.

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