(MoneyWatch) Twice each year, Standard & Poor's puts out its active versus passive scorecard, reporting on how actively managed funds have done against their respective benchmarks. Every time, the results are pretty much the same, demonstrating that active management is a loser's game -- in aggregate those playing leave on the table tens of billions of dollars in the pursuit of alpha (outperformance, adjusted for risk). The following is a summary of the findings of S&P's Year-End 2011 Indices Versus Active Funds (SPIVA) Scorecard:
Failure across the board
Over a five-year horizon, a majority of active stock funds in all nine U.S. style categories lagged comparable benchmark indexes. The percentage that failed ranged from 55.1 percent to 68.2 percent. The outcomes don't change much when we look at equal-weighted returns or dollar-weighted returns. On the international side, the majority of active managers lagged in three of the four categories, including emerging markets, where 83 percent failed to beat their benchmark. The exception was international small-caps. Note that during the period the international small index lost almost 6 percent a year. Before you jump to the conclusion that active managers have an advantage in bear markets, read on.
While the conventional wisdom is that the large-cap market is efficient and should be indexed, but the small-cap market is inefficient and active management should be used, SPIVA has consistently shown that indexing works as well for U.S. small-caps as it does for U.S. large-caps.
Active management no help in down markets
While in theory bear markets favor active managers (because they have the opportunity to move to cash ahead of or during bear markets), that opportunity hasn't translated to reality. In the two bear markets the SPIVA scorecard tracked over the past decade, most active stock managers failed to beat their benchmarks. In the 2008 bear market, in only one of the nine style categories did the majority of active managers outperform. In the 2002 bear market, the majority outperformed in just two (and one of the two was barely a majority at 50.6 percent).
As another challenge to active management, over the past decade, over a three-year horizon, only half to three quarters of funds survive and remain in their original style box (creating the risk of style drift for investors, which causes them to lose control over the risk of their portfolio).
Bond managers didn't fare better
The evidence on active bond managers is even worse. Active bond managers failed in all 13 categories over the five-year period. The percentage of funds failing ranged from 60.5 percent to 97.6 percent, with seven categories showing failure rates over 90 percent.
Obviously, the majority of investors in active funds are taking all the risks of investing and not being properly rewarded for taking those risks, transferring tens of billions from their accounts to the wallets of active managers. The question is why do they keep doing this? Evidence suggests that one explanation is that they are simply unaware of how poorly they are doing. Another explanation is that hope springs eternal.