It’s no secret that actively managed mutual funds tend to lag their benchmarks as a group, but the final numbers for 2014 are even worse than even the most ardent proponents of indexing could have hoped for.
If you felt like your funds weren’t keeping up with the broader market last year, there’s a reason for that: They weren’t.
Unless you were among the lucky few to pick the small sliver of actively managed funds that outperformed, you would have missed the boat in virtually every category.
The Numbers
Every six months, Standard & Poor’s releases the widely-followed SPIVA Scorecard, which tallies up the aggregate results for active managers. The entire report provides plenty of interesting details, but a few gruesome highlights from 2014 offer a sense of the larger picture:
- U.S. stock mutual funds underperformed, and badly. All told, 87.2% of all domestic equity mutual funds lagged their benchmarks in 2014. And not one of the 13 sub-categories (i.e., large-cap growth, large-cap value, and so on) beat their bogeys.
- Large-cap growth funds couldn’t win. A full 96% of large-cap growth funds underperformed, which indicates that active managers are so poor at stock picking that not even the laws of probability can overcome their shortfall.
- Small-cap mutual funds weren’t any better. Even in the small-cap space — which fund company whitepapers will tell you is a space where stock-picking can add value due to market inefficiencies — 94.3% of managers underperformed.
- International stocks? Nope. The relative inefficiency of the foreign markets is also supposed to offer more fertile ground for active management, but again the numbers don’t bear that out. In 2014, the global, international and emerging-market categories all lagged their benchmarks as a group (77%, 69%, and 69%, respectively), which isn’t necessarily a surprise. However, global small-cap funds — which supposedly invest in the most inefficient market segment of all — also failed, with 69% of funds in the category underperforming.
- Bonds were better, but still not good. Bond funds performed better on a relative basis than stock funds, but investors still didn’t get what they paid for. Actively managed funds lagged in nine of 14 categories, with the worst being investment-grade long funds (98.3%) and government long funds (97.7%).
The Longer-Term Results Are Equally Dismal
A look through fund-company commentaries will reveal a trend: Many funds have cited 2014 as being a particularly tough year for active managers in general. This is true, of course, as the numbers above reveal … but the past year was by far an isolated case.
The SPIVA Scorecard also tracks results over the three-, five- and 10-year time periods, and the numbers aren’t pretty.
Domestic equity funds lagged considerably across all time frames, with 77%, 81% and 77% underperforming. Notably, in not one of these intervals did any groups manage to outperform their benchmarks. The best? Large-cap value funds’ 10-year results, where “only” 59% underperformed.
All four categories of international equity funds lagged during all longer-term periods as well, although about half of all international small-cap funds outperformed in the three- and five-year intervals. It’s a sad commentary when a coin-flip outcome counts as relative success.
Bond funds have held up relatively well in the three- and five-year periods, with five of 14 categories outperforming their benchmarks in each case. However, investors should question how long this can continue since so many fixed-income managers juiced returns by taking on credit risk in areas such as high yield and emerging market bonds during this time. If these segments continue to lag as they have in the past year, these longer-term numbers could turn south fairly quickly.
It should also be noted that mean reversion comes into play over the ten-year period, during which only two of 13 categories (investment-grade intermediate and global income funds) just barely outperformed, with the rest falling short.
Don’t Just Blame the Fees
It’s worth noting that the shortfall in performance hasn’t been simply the result of expense ratios. A look at the absolute return numbers show that mutual funds fell short by far more than the gap that could be attributed to fees alone.
For instance, domestic stock funds delivered an average return of 7.8% in 2014, when all funds are weighted equally. (Weighted by assets, with more importance given to the largest funds the return was 9.4%). Either way, the return fell well short of the 13.1% gain for the S&P Composite 1500 Index.
The lesson: Investors are not only getting dinged with higher fees in actively managed funds, but the underlying performance of the funds’ managers is putrid as well.
The Takeaway
If you still own any actively managed funds, it’s worth taking a few minutes to read through the SPIVA report. The numbers clearly show that the odds stacked against you are so high that it will be almost impossible to keep pace with the broader market over time.
Even if you were fortunate enough to have chosen a fund that managed to outperform in 2014, the longer-term data clearly shows that the odds of longer-term repeatability are exceptionally low.
If there was any remaining question about the superiority of index funds — or the notion that actively-managed funds have any place in an individual investor’s portfolio — this latest report ought to remove all doubt.
