By LARRY SWEDROE
Persistence of performance is an important issue for those who believe that active management is the winning strategy. The reason is that if persistence is not significantly greater than should be expected at random, it’s extremely difficult for investors to separate skill-based performance (which might be able to persist) from luck-based performance (which eventually runs out). Reading Standard & Poor’s March 2019 report Does Past Performance Matter? The Persistence Scorecard provides familiar evidence: Persistence of performance tends to be less than would be randomly expected.
The following are highlights from the just-released March 2019 Persistence Scorecard, with data through March 2019.
Of the 498 domestic funds that finished in the top quartile over the five-year period ending March 2014, only 16.1 percent managed to repeat that performance over the five-year period ending March 2019. Randomly, we would expect 25 percent to do so. On the other hand, 31.5 percent of the first-quartile funds fell into the fourth quartile, more than would be randomly expected to do so.
Breaking it down by market capitalisation, just 18.8 percent of large-cap funds, 13.5 percent of mid-cap funds, 23.4 percent of small-cap funds and 15.7 percent of multi-cap funds that were in the top quartile as of March 2014 managed to remain in the top quartile at the end of the five-year period ending March 2019. Again, we would expect 25 percent to do so randomly. In addition, with the exception of the category of large-cap funds, more first-quartile funds fell into the fourth quartile than repeated.
Of the 996 domestic funds that finished in the top half over the five-year period ending March 2014, only 38.2 percent managed to repeat that performance over the five-year period ending March 2019. Randomly, we would expect 50 percent to do so.
Breaking it down by market capitalisation, 38.8 percent of large-cap funds, 28.2 percent of mid-cap funds, 42.3 percent of small-cap funds and 32.4 percent of multi-cap funds that were in the top quartile as of March 2014 managed to remain in the top quartile at the end of the five-year period ending March 2019. Again, we would expect 50 percent to do so randomly.
The bottom line is that there was little to no evidence of persistence in performance greater than randomly expected among active equity managers.
The paradox
The year-end 2018 Scorecard reported that over the latest 15-year investment horizon, 92 percent of large-cap managers and 91 percent of small-cap managers failed to outperform on a relative basis when calculating performance data with results from closed funds included. That’s even before considering that the largest expense for the taxable investors in the typical actively managed fund is taxes. Despite the persistent failure of active managers to outperform, active funds still manage far more assets than passive funds.
Unfortunately, many institutional investors (such as endowments and pension plans) still engage in the practice of selling funds or firing managers once they have underperformed the market over the previous three or five years, typically replacing them with funds or managers that have recently outperformed. They do this while ignoring the evidence from studies such as The Selection and Termination of Investment Management Firms by Plan Sponsors by Amit Goyal and Sunil Wahal that have found the fired funds go on to outperform the newly hired funds. While repeating the same due diligence process, they never seem to stop and ask: “If the process didn’t work previously (which is why I’m firing fund managers), why do I think the process will work this time?”
They are doing what Einstein called the definition of insanity!
Summary
The SPIVA scorecards provide powerful evidence regarding the persistent failure of active management’s ability to persistently outperform. They also provide compelling support for Charles Ellis’ observation that, while it’s possible to win the game of active management, the odds of doing so are so poor that it’s imprudent to try — which is why he called it “the loser’s game.”
LARRY SWEDROE is Chief Research Officer at Buckingham Strategic Wealth and the author of several investing books.
Larry is a regular contributor to TEBI. Here are some of his other recent articles:
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