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Three in four active equity managers have underperformed

The latest Spiva scorecard is not encouraging for the average investor.
Over all time periods, in all markets, more than half of active equity funds underperform a broad market benchmark. Image: Shutterstock

Over the five years to the end of June this year, 74.19% of active South African equity funds underperformed the S&P South Africa Domestic Shareholder Weighted (DSW) Capped Index, according to the latest S&P Indices Versus Active (Spiva) scorecard. In other words, only a quarter of fund managers delivered an above-market return.

On an asset-weighted basis, the average annualised return investors in South African equity funds saw over this period was 3.57%. The S&P South Africa DSW Capped Index was, however, up 4.28% per year over the same time. This means that the average investor in an actively managed South African equity unit trust underperformed the market by 0.71% per year.

When looking at only the past three years, active managers have fared slightly better. Only 52.91% have underperformed the S&P benchmark, and their asset-weighted average performance has been higher.

Source: S&P Dow Jones Indices, Morningstar

Source: S&P Dow Jones Indices, Morningstar

It is fair to say that this has been a difficult period for local managers, given that the local market has generally been weak, with periods of performance coming from isolated sectors. However, the recently published Spiva scorecard for Europe shows that active managers in that region have fared no better.

For the five years to the end of June 2019, 77.53% of European equity fund managers underperformed the S&P Europe 350 Index. The asset-weighted average return for European equity funds was also 0.79% below the index.

This is therefore not a phenomenon specific to the South African market.

It’s also worth considering that local managers managing global equity funds have fared even less well. As the table above shows, just 3.12% of South African-domiciled global equity funds outperformed the S&P Global 1200. In a universe of 34 funds, that represents a single manager.

A fair comparison?

Some active managers have criticised the Spiva scorecard on the basis that no local funds actually benchmark themselves against these S&P indices. This is however a moot point, because when compared against their own benchmarks, active funds do not fare any better.

The S&P South Africa DSW Capped Index is also a pretty good representation of the investible market on the JSE. By capping the weighting of individual stocks at 10% and adjusting for the percentage of the market capitalisation held by South African investors, it is a fair reflection of the opportunity set for active managers.

Read: This is not fake news

The reality is that most active fund managers struggle to add value, where value is defined as outperforming a broad market benchmark. That has become glaringly apparent as the data from Spiva and similar studies over many years continues to produce consistent findings, not just in South Africa, but across the world.

The investors’ dilemma

For investors, this highlights the challenge in selecting an active fund manager. Over all time periods, in all markets, more than half of active equity funds underperform a broad market benchmark.

In South Africa, the Spiva figures suggest that only 42 out of 162 funds have delivered outperformance over the past five years.

There are therefore managers who add value, but it’s not easy for investors to identify who might be among this minority beforehand.

To illustrate this, consider that the five top-performing active South African equity unit trusts over the past five years have been the Fairtree Equity Prescient, Investec Value, Autus Prime Equity, Aylett Equity Prescient and 36One BCI Equity funds.

Five years ago, these portfolios had a combined market share among South African general equity funds of 3.4%. From those figures, it’s obvious that they were not being widely recognised as the future outperformers.

Given this challenge, investors need to be clear on how and why they use actively managed funds in their portfolios. The reality is that active does offer the potential for outperformance, but also the risk of underperformance. Since they cannot be certain of what they will get beforehand, investors have to be willing to accept either outcome.

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Active managers: Hey, some of us are good at this.

Nassim Taleb: No, you are only fooled by randomness.

Excellent interpretation.

Any fund manager that did well this year should not expect to do similarly next year.

“ It is fair to say that this has been a difficult period for local managers, given that the local market has generally been weak, with periods of performance coming from isolated sectors.”

And here I thought that in down markets especially, is when active managers come into their own.

The proof is in the pudding as they say.

I agree. Am aware of many articles which implies that one certain strength of an active asset manager is that they should ideally perform better in bear markets (i.e. based on the fact that typically index-tracking UT-funds or ETF’s will simply follow the market down…tracking it, while active funds can make intelligent decisions).

After many decades of bear markets, the pudding is not as clearly evident (nor tasty)

And during bull markets, how many local asset managers did not foresee the Resources run coming?

( fairness to AM, its easy to use hindsight)

Their stories change to whatever will sell at that point in time.

After all, they make their money from sales (fees) and not from performance.

If the investor wants to beat active managers, simply buy the index. The index is the benchmark of active managers. When the index isn’t the benchmark of an active manager it just means that the manager changed their benchmark to make themselves appear better.

Over protracted time, like 20 years, show me any active manager that has beaten the index.

Should be that the proof of the pudding is in the eating… as they say.

Excellent article. Thanks.

Is 5 years and appropriate term for an equity fund to be measured?

…10 and 15 year figures show even lower probabilities of active outperformance
What about 15 year performance?
“The overwhelming presumption for financial advisers and planners, therefore, is that they should avoid recommending actively-managed mutual funds to their clients. It’s hard to see how an adviser can claim to be putting their clients’ interests first when recommending a type of fund with such dismal odds of success.”

No. It is very difficult to tell the difference between luck and skill. Depends on the quantum of out-performance and the holding period.

Basically you are trying to detect a “skill’ signal in data with a high standard deviation. Equally difficult to detect a poor active manager.

Using similar time periods as discussed above..A manager with a long term excess return of 3% will under-perform the broad based US market approximately 30% to 25% % of the time over 3 and 5 years (around 1 in 3 or 1 in 4 chance of not beating the market – irrespective of skill). If the excess return is 1%, the probability of out-performance falls to 57% – 59% over 3 to 5 years. Even over 30 years the probability of out-performance is only 70% for an excess return of 1%.

See the “Stocks for the Long Run” by Jeremy Siegel.

So by buying a simple cheap index ETF you have around 75% chance of beating the pro’s.

I like it.

You incorrectly assume your cheap ETF will achieve the same return as the index. The indexed investment vehicle ALWAYS underperforms.

From where I sit on my little perch, I see that active managers can outperform in a trending market. In a sideways market, as we have had for the past 5 years, it is a coin toss, a bowl of soup in a tumble-dryer. The best-performing money manager was the teller at the bank. Cash outperformed in this deflationary environment that is the result of an international contraction of lending. The US Fed outperformed everybody.

There should be some financial advisors here, so question: are financial advisors differently rewarded for recommending ETF or Active?

There are some really cheap ETF globally. eg SPY in US is massive, fees are something like 0.05% as they make their money on script lending – probably to the hedge funds and actives that try and play options market out of desperation 😉

And, by definition, 100% of passive managers underperformed the benchmark

This argument is often advanced by fund managers and those with a strong bias to active investments. What says the evidence?

In SA General Equity and Large Cap Fund category, over 5 years
Satrix Top 40 comes 23rd out of 161 funds
The Satrix Divi comes 17th out of 161 funds
The Satrix Momentum comes 5th out of 161 funds
(the active luminaries are left in the dust)

What about Global Equity Funds, where fund managers have the whole world at their fingertips and could surely demonstrate their stock-picking skill!
In Global Equity Fund category, over 5 years
Sygnia World is 6th out of 45 funds
Satrix World is 7th
Orbis 33rd, Foord 39th

You could argue that fund manager skill will really be evident when fund managers have all asset classes in the world as their oyster. So what about the SA Multi Asset High Equity category (where the very large pool of retirement funds are invested)
Sygnia Skeleton 70 Balanced Fund is 13th out of 138 Funds
Satrix Balanced is 22nd
Allan Gray 42nd
Coronation Balanced Plus 66th
Foord 110th
PSG 86th–Multi%20Asset–High%20Equity&period=5yr

Their is an adage in sport, “Look at the scoreboard”

Where are you going to put your retirement money?
An active, underperforming expensive fund or
A passive, cheap, superiorly performing fund

The data from the above, Spiva and Standard and Poors Indices leave little doubt about the odds!

What do you think about the fact that 100% of passive funds underperformed the index PLUS more actively managed funds beat the average passive fund than the index?

What I will say is:
Yes the passive fund will lag the index slightly due to the fees and tracking error – therefore pick the cheapest and be certain of what you get.

But the I will ask, who will that 1 in 4 active manager be that will beat the benchmark this year (or 5)?

This argument is based on semantics and all know it.

Maybe it is only semantics when it does not support your point of view! Low cost indexing is a great way to invest but it is not for everyone and not all indexing is low costs and not all indexers are great at tracking. Once you can accept the pros and cons of indexing you become a better investor in my view.

Should one not separate high and low risk investments and then compare high risk with high risk and low risk with low risk investments?

Active management is a strong word for what they do.

Check out performance of Investec Managed Fund, best performer because they are overweight in bonds. The other managers are overweight in equities that have been on a continuous downward spiral (e.g. Sasol, BAT, etc).

Outstanding article.

Now does one take advice/a punt that you can select the one out of four managers who previously delivered alpha or do you go for low cost, highly liquid and leverage-able ETFs?

I think that it is an easy decision. Look at the previously great names-Coronation, Foord , Alan Gray -negative alpha and sky high fees for years.

FIRE THEM! The rest of the planet is redeeming active managers fast and investing in ETFs

End of comments.





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