Active vs Passive Performance: S&P’s Andrew Innes On His Index vs Active Report
Here's my interview with Andrew Innes of S&P Dow Jones indices. He's the author of the European version of the S&P SPIVA report, that's the S&P Index Versus Active report. What this does is inform the debate about active versus passive fund management by tracking thousands of fund managers over a very long period of time, often up to a decade, to see whether they managed to do what they're paid to do which is to beat their benchmark.
Now what this shows is quite depressing because many of them fail to beat their benchmark and what we're actually witnessing is a destruction of wealth on an almost industrial scale. But to hear Andrew tell it in his own words here is.
Alpha and Beta
Ramin: Well Andrew it's brilliant to see you again, we talked last year I believe about your results and your SPIVA report so that's the S&P index versus active report and you're the lead author I believe of the report?
Andrew: That's right
Ramin: So this talks about how much active funds beat their benchmark so maybe you could start off by just talking about alpha and beta, the big Greek letters, and exactly what they mean?
Andrew: Okay so we start with beta that means basically the performance of the market. So in the case of our indices, which are typically market cap weighted, the beta is just the performance of our passive benchmark and so for our European scorecard the European fund category is compared against our index which is the S&P Europe 350. So that's the beta performance.
When it comes to active fund managers they are typically trying to outperform that passive index so that benchmark so the part of their ability to outperform the benchmark (the beta) is the alpha. And essentially that is what they're hoping to achieve, that's the success at which they're measured against.
And typically the fees that they charge could be a proportion of that alpha as well, or maybe sometimes the fees are set.
Ramin: Okay so what you're paying for is somebody to outperform the global markets or the particular market you're interested in. So if it was a UK investor for UK stocks you'd want them to beat, say, the S&P UK index because you can buy the S&P UK index very cheaply. So by paying them more hopefully they outperform that index is that right?
Andrew: Yeah I mean that's that's their goal so typically that's what they hope to achieve and as you mention in most cases you'll find index passive products which is just based on benchmark performances which are much lower in reality to those those active strategies and there's and the fees that are associated with active funds.
So I guess the real importance for SPIVA is to not only show how well active fund managers are doing against the benchmarks but to really make that data available to everyone because we're in an environment now as ever increasing opportunities for investors and market participants to choose between either an active fund or a passive index.
So we believe that we should present all this data in a transparent manner so people can really evaluate for themselves whether there's there's real value coming from the active managers and whether they they're worth the fees that they're charging.
Underperformance: The Big Picture
Ramin: So maybe you could kind of summarize what the overall picture is for the report and then we'll perhaps dig into some of the details. So you know I mean for European funds overall how well have they done their job?
Andrew: I mean this SPIVA is produced every six months and whether we look at this SPIVA scorecard or we look at the ones from previous years the same themes are always evident, and that is that in most cases the majority of active funds failed to beat their benchmark and that's even on a short time horizon and a long time horizon.
But if there are cases where maybe on the short term that the majority funds are capable of outperforming the benchmark we don't see that persistence we're unable to see them achieve that outperformance over longer term horizons.
So for instance the the key headline figure that we quoted for the SPIVA Europe scorecard this time was just looking over the last one year and we quoted that 59% of the active fund managers from Europe actually were beaten by the respective S&P index benchmark
Ramin: So that's very low bar isn't it just to kind of beat the overall market?
Andrew: It means essentially that if you're you were to choose a fund one year ago that only 59% of those funds would have beaten the benchmark so in most cases you would have been better just selecting a passive benchmark.
Ramin: And it would have been cheaper.
Performance Deteriorates Over Time as Fees Compound
Ramin: Okay so perhaps the other thing to think about is your investment horizon so let's say I've got I don't know a thousand funds to choose from and I know I'm going to invest that money for ten years so I know that one of the things you look at is how the performance varies over longer and longer term horizons because you might expect if you have skillful managers that even over the long term horizon they'd still be adding more value they could have just been unlucky for the first few years what's the actual picture that you see?
Andrew: No the actual picture is actually the reverse is true it gets much much harder for an active fund manager to outperform over the long term so the figure I just quoted which is fifty-nine percent over one year for those European fund managers in European equities actually rises to I think over maybe eighty seven percent over ten years so we look at one year three year five year and ten year and and that trend is true across multiple regions multiple categories and it's been the same theme we've seen time and time again across our SPIVA reports and it essentially it comes from the fact that the fees that these active fund managers are charging have only a maybe a small impact on a small time frame sort of one year the fee's only charged once but you get this compounding effect from the fees which makes it increasingly more difficult to outperform over long term
Ramin: Because we often think about returns compounding if we save money but people don't think about the compounding of fees but it's very clear when you look at the long term that's that's going to be a big effect?
Andrew: Yeah we can see the effect and it is big
Inefficient Markets Not Better
Ramin: So effectively it's just a hurdle for the for the active managers I see. So the other kind of argument with active management is that if you look at hugely researched markets like the US it's very difficult to find alpha. In other words stocks which are going to outperform the overall market because everybody's looking at the same data it's publicly available but if you look at less efficient markets like emerging markets where the data's not so available there's more opportunity for generating alpha is that what you see?
Andrew: I mean that's the theory and I've heard the theory but what we see in SPIVA I mean this is from a European investors based perspective but we see that the emerging market category for equities from European investors looking out to emerging market equities that they are usually one of the worst performing categories in our reports so just this time we looked at a one-year number and only one in five funds had outperformed over the latest year and actually over a ten year period it rose to or it shrank to one in a hundred so that means that of all the funds in existence ten years ago you had only a 1% chance of choosing the fund that would have survived and outperformed that 10-year period
Ramin: Okay this survivorship thing is kind of interesting because apparently a lot of the funds that you buy today may not exist or might might get merged in the future so what are the rough statistics for that?
Andrew: yes so when we're quoting the percentage that outperform we're also including or excluding those which didn't survive so we're essentially saying this is the figure that survived and beat the index but if we're to isolate just the elements of count the funds that didn't survive we see that across most categories that over a 10-year period it's something in the range to forty to sixty percent actually survive that period so if you think that around half don't survive over ten years if you're trying to select a fund with the expectation to hold it for ten years you've got a 50/50 chance of that fund surviving and then you've got on top of that think it is the fund gonna survive and outperform.
Ramin: So the odds are really stacked against you in that case?
Andrew: Yeah I mean I mean the assumption is that if a fund doesn't survive as well it's it's usually due to poor performance because those funds which are doing particularly well and outperforming aren't necessarily going to be the ones that didn't survive were merged or became obsolete and so that survivorship statistic is really important because it gives us an insight into the potential number of funds that maybe weren't performing very well during that period
UK Small Caps
Ramin: Okay and in terms of these small and inefficient markets what about UK small caps because I think that was kind of one glimmer of hope in the absence of alpha?
Andrew: Yeah you're right to point out the UK small caps because for a few years now that category has stood out for instance I think it was one of the better numbers for the latest one year in that only a third underperformed the S&P UK small cap benchmark so that's relatively good figure it means two thirds of the UK small cap funds outperformed but again I have to keep stressing we need to look at a longer term horizon to really judge the performance of these active fund managers and when we look at UK small cap the figure rises to just like most of the categories around 80 percent over 10 years that underperform the benchmark.
Ramin: So you've seen some short-term success and the so perhaps you never know when we're talk in the next three years maybe we'll see that roll into the ten year into the ten year bucket? Okay and the other question I had was about sterling funds in particular because you know if you're a UK investor chances are you'll buy the Sterling denominated fund so if you look at those in particular as a subset of the European funds how did the statistics look relative to the rest of Europe are we better or worse on average?
UK Better Than Europe?
Andrew: There is some evidence in the SPIVA report because we've got some comparable categories that we can look at the Sterling based funds for US and global equities and then there's a European European based equivalents and we do see at least over the last couple of SPIVAs that UK active managers have been slightly better in terms of their performance against those global benchmarks.
So it's it's difficult to say for certain whether that means active fund managers in the UK have more skill than their European based counterparts because what we can't take into account is the currency risk that may be playing in there whether it's intentional or unintentional currency risk and how they hedge each of their portfolios and so we really can't say for certain the reason but it does seem to be a some data in the report that suggests that there could be a difference there.
But again if we just look at the the figures even though they might be slightly better for UK sterling based ones we're still seeing around UK equity about 51% were beaten by the benchmark and that rises to the vast majority again over ten years
Future SPIVA Changes
Ramin: And I understand that you're going to make some changes to the SPIVA in future so perhaps include some graphs?
Andrew: I mean that's still under discussion the important point for us is to get the message out it's important for us to be transparent and present the data in an effective way as possible so we will be looking into including other ways to address all the the messages whether that's charts or variations on the reports that's yet to be seen because the website's great if you look at the website you can actually see the kind of global map and you can look at each of the regions and then drill down into the reports which I think is great so I guess you're halfway there?
Andrew: It's a really useful tool yep
Ramin: And then my final question is about the persistence scorecard because what you look at in the US so you have this fantastic report called the persistence scorecard which looks at the consistency of outperformance to see whether whether it lasts is there any plan to do that for Europe?
Andrew: Yeah there's every possibility that that will be introduced into Europe because as you mentioned it is in the US and just to re-clarify rather than just looking at the performance over a single window whether that's one year or ten year it looks at that consistency month-on-month is an invest is an active fund manager capable of producing above average returns month after month after months and what percentage of them are able to achieve that so yeah I think that would be a useful introduction to the SPIVA Europe scorecard.
A Small Number of Funds Drive Outperformance
And another element of the report is not only given the the numbers that underperformed and outperformed but it's also looking at the distribution as well so there's a report in the SPIVA scorecard that shows you what the average fund performed what the first quartile fund performance was so you can see that skew that even if maybe collectively the active fund management industry did it may have been really limited to a very small distribution of the opportunity set which from an investor's point of view isn't good news because it makes it even harder you've got if you're only thinking of choosing one active fund if all the outperformance is located in a very small distribution it makes it very very difficult to outperform.
Ramin: And I guess if you don't have consistency it's you know past performance isn't necessarily going to guide you to the to the winners in the future?
Andrew: Exactly, just choosing a fund that outperformed historically there's no guarantee for any future success.
Ramin: So it would be great if we did have that persistence scorecard because then we could see the actual numbers but it's unlikely to be hugely different from the US, I guess?
Andrew: Yeah I mean as I said earlier that the themes that emerge from SPIVA whether it be across regions or across each time we periodically update them they are largely consistent brilliant well thank you so much for your time again Andrew and thank you to S&P Dow Jones for producing the report which frankly gives you an amazing insight into active fund performance so thank you again and hopefully we'll we'll talk again when the next report is published
Andrew: Absolutely, thank you Ramin
So you can see why I find that report quite depressing what Andrew was telling us is that many of these active fund managers are selling a service which they failed to provide. But of course if they fail they still take their fee.
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