Passive vs Active Investment Management (Mutual Funds vs ETFs)

It seems like a never-ending discussion: mutual funds vs ETFs, or active versus passive investing. Fund managers claim that due to a savvy investment strategy, they are able to cherry pick and compose a portfolio with for the larger part winning stocks. In the long run, this should lead to a clear outperformance. On the other side, backed by academic literature, ETF investors claim that beating the market is unrealistic and that passive index trackers are all an investor need. The recent S&P Indices Versus Active Funds (SPIVA) Europe Scorecard by index builder S&P Dow Jones Indices (SPDJI) proves that the latter group may have it right, although the debate will probably continue.

SPIVA Scorecards were introduced in 2002 to make a substantial contribution in the active vs. passive debate. The best way to contribute is by providing data which are easily to understand. The SPIVA Euro Scorecard offers an insight in the performance of European equity funds in various classes (all data were based on June 30, 2015). Interestingly, there’s a significant difference in the amount of funds able to beat the market on a one-year basis. Nevertheless, the picture is not in favor for active fund managers. Whereas 55% of fund managers with a Europe Equity mandate fails to deliver, almost 84% of managers with an US Equity mandate is not able to beat the broad S&P 500 Index. According to SPDJI, there may be a simple explanation: during the first half of 2015 the US market was largely moving sideward, where Europe was confronted with the Greek crisis. The argument goes that active managers can show their real ability in times of stress. However the argument doesn’t hold for emerging markets, which showed a very volatile 12-months period, but fund managers still largely lagging their benchmark.

As years go by, a potential advantage for active managers seem to fade further. Shocking fact: over 98% over European fund managers with an US Equity mandate fails to beat the market. A large part may be explained by costs. Expense ratios for European equity funds are well above their US counterpart, let alone ETFs. Charging 1-2% a year makes a significant difference in yield over a 10-year timespan. The score for Emerging Markets Equity is also poor (97% of underperforming managers). This may indicate that the generally higher fees for this type of funds don’t make up for special expertise in emerging markets. Due to country risk and often corporate governance challenges, one could argue there’s a good case to bring in a fund manager with specific knowledge of local markets. But apparently only a few managers are worth the money. Only one positive note: when focusing on a single country, the added value of an active approach seems to increase. The German and France Equity mandates show better rates than those of broader investment mandates. However, 83-86% unable to beat the index over a period of 10-years is rather poor.

Not surprisingly, a large number of funds is unable to survive over a 10-year time span. The SPIVA-study notes that roughly 50% of European equity funds are either liquidated or merged over the past 10 years. With these figures, investors have a solid rationale for passive investment. Although one should realize that due to yearly costs, an ETF will also fail to beat the benchmark. However, with costs only a fraction (0.05-0.15% a year), the underperformance will be likely far less than when investing in an actively managed mutual fund. So let’s get passive!


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