Most large-cap fund managers get a failing grade

Proponents of active fund management, in which professional money managers are paid to provide expert advice, often claim that the approach is especially valuable in turbulent markets.

So how has that played out during the past 12 months, a time when U.S. stocks have seen the type of volatility that's giving many investors indigestion? Not so well, according to a report from S&P Dow Jones Indices.

Almost two-thirds of large-cap managers underperformed the benchmark S&P 500 during the 12 months before June 30th, the study found. Performance over the longer term was even worse, with roughly 81 percent and 80 percent of large-cap managers failing to match that benchmark over five and 10 years, respectively.

Proponents of passive management, also called index investing, may be rubbing their hands with glee at the findings, which jibes with other research that raises questions about active management. Mutual fund giant Vanguard and other money management firms that focus on low-cost index funds have long argued that this approach is not only cheaper, but also guarantees better returns for investors. Active large-cap funds charge an expense ratio of about 125 basis points, compared with 44 basis points for indexed equity funds, according to the Investment Company Institute.

Yet the study also provides some hope for active managers and their fans. For one, while 65.3 percent of large-cap managers failed to match the S&P 500, that's actually an improvement from just six months ago. At that time, 86 percent of all U.S. large-cap managers failed to match the index.

That could provide evidence that some managers are showing their mettle during tough market conditions, although Aye Soe, senior director of index research and design at S&P Dow Jones says that more time is needed to test the theory.

"The volatility we saw in the market really came in full swing after the second quarter," she said, noting that the report's cutoff point was June 30. "We saw some modest fluctuations in the second quarter, and what we noticed is that across all the categories there is a slight drop in the percentage of active managers underperforming the benchmark versus six months prior."

She added, "It's early and premature to really say that this is attributable to skill. It could be luck. We would like to wait six to 12 months to make a definite conclusion."

Of course, S&P Dow Jones Indices could be considered as having a horse in the race, given that the company's businesses is partly based on licensing indexes, which are often used to create passive funds that mirror the underlying basket of stocks. Soe noted that it's a question she often receives.

"As an index provider, we do highlight the benefits of passive investment, but we let the numbers speak for themselves," she said. "What we are saying is not that active management is dead. If you look at the numbers over 10 years, you still have 20 percent of active managers who are still beating the benchmark, and that's quite impressive over a 10-year period."