Investors are faced with a choice between nearly 8,000 distinct mutual funds (excluding multiple share classes of the same fund), according to data from Morningstar. How can investors be expected to choose wisely from such a large investment universe? As it turns out, the first step may well be to filter out all actively-managed mutual funds.
Standard & Poor’s, a leading financial market benchmarking firm, prepare a semi-annual analysis called the S&P Indices Versus Active Funds Scorecard, or SPIVA Scorecard. The Scorecard seeks to compare the performance of various mutual funds to relevant benchmarks tracked by S&P. The Scorecard is particularly useful for the following reasons:
- S&P considers all funds available at the beginning of a sample period, and not just those funds which survived through until today, thereby eliminating survivorship bias.
- The Scorecard compares each mutual fund to a relevant benchmark, as opposed to comparing all funds to a single benchmark such as the S&P 500.
- S&P provides analysis on an asset-weighted basis, which reflects the fact that an investor is more likely to have access to, say, the American Funds Growth Fund of America ($139 billion in assets) than the Kirr Marbach Partners Value Fund ($58 million in assets).
For the period ending 12/31/2019, the SPIVA Scorecard showed that on a 10-year trailing basis, between 78% and 97% of US equity mutual funds were outperformed by a relevant S&P index. This means that even in the best-performing category of active US equity mutual funds (those in the Mid-Cap Growth space), only 22% of funds outperformed their benchmark. This lends strong evidence to the wisdom of utilizing index funds (rather than actively-managed funds) to assemble a portfolio.
We find two common objections to the advice to avoid actively-managed funds – the first is to only use actively-managed funds in the “less-efficient” asset classes, such as small-company stocks or emerging markets stocks. However, the SPIVA Scorecard confirms that active-manager underperformance is as robust in these asset classes as it is in more common asset classes such as large-cap US stocks. The second objection we hear is that investors should limit their choice of actively-managed funds to those with good track records. Fortunately, S&P also publishes The Persistence Scorecard, which illustrates that top-performing actively-managed funds over an observed period are not statistically more likely to remain top-performing funds in the following period.
Finance author Charles Ellis offered this sage advice in his book ‘Winning the Loser’s Game’: “Everything I know is known by the market and worked into the market…The best way to invest is through benign neglect. Get your asset allocation right and leave your investments alone.” We couldn’t agree more!
Daniel Bauer, CFP® serves as the Chief Investment Officer of AllSquare Wealth Management, LLC. In this capacity, his responsibilities include developing, implementing, and monitoring investment portfolios for customers of the firm.
AllSquare Wealth Management, LLC is a registered investment adviser.
