Investment Report: October 3, 2012
Vast majority of Fund Managers again fail to beat their Index Benchmarks "The best way to own common stocks is through an index fund." Warren Buffet, Berkshire Hathaway Inc. 1996 Annual Report
Warren Buffett has once again been proven correct and the essential RVW philosophy has again been vindicated and validated. Indexing always beats active management in the long run – and the primary determinant of performance is asset allocation rather than stock picking and market timing.
The latest data compiled by Standard & Poors and just released, once again shows that the vast majority of US managers and mutual funds consistently underperform their respective index benchmarks over the past 1, 3 and 5 year periods. This is true of both equity and fixed income (bond) fund managers. Globally the trend is getting far worse for active fund managers. At the end of 2011, 69% underperformed the S&P 500 Index over the prior three year period. Sadly by mid 2012, 85% failed to beat the S&P 500 over the past 3 years, with 86% of mid cap managers also failing to beat the mid cap S&P 400 benchmark. Similarly, on the small cap side, 84% of small cap managers failed to beat the S&P 600 Index’s performance. Over the past 12 months, 86% of US large cap managers failed to beat the S&P 500 benchmark, while 71% of mid cap managers failed to beat their mid cap S&P 400 benchmark. On the small cap side, 91% of small cap managers also failed to beat the S&P 600 Index benchmark’s performance.
Passively Managed- US institutional equity (Market Share 20052005-2012)
40%
35%
35% 30% 25% 20%
20%
21%
2005
2006
24%
27%
28%
37%
31%
15% 10% 5% 0%
2007
2008
2009
2010
2011
2012
Source: Financial Times and eVestmentAlliance, July 9 2012
Perhaps most surprising, is the dismal performance amongst Fixed Income (bond) fund managers. Less than 5% of US bond managers beat the US Treasury long bond benchmark index over the past 1, 3 and 5 years periods. Among High Yield bond managers, fewer than 10% beat the index over the past 3 and 5 year periods. While in the Emerging Market bond space, 87% of managers underperformed their benchmark.
% of US Equity Ma nagers underperforming the Index (June (June 330, 0, 20 2012) 12) 1 1 year year
3 3 year year
5 5 year year
Large Large--cap cap
85.5% 85.5%
85.2% 85.2%
65.4% 65.4%
Medium Medium--cap cap
70.8% 70.8%
85.6% 85.6%
81.6% 81.6%
Small Small--cap cap
91.0% 91.0%
83.9% 83.9%
77.7% 77.7%
All All US US Equity Equity
92.2% 92.2%
85.3% 85.3%
76.2% 76.2%
(vs. (vs. S&P S&P 500 500))
(vs. (vs. S&P S&P 400 400)) (vs. (vs. S&P S&P 600 600))
(vs. (vs. S&P S&P 150 1500) 0)
Source: Standard & Poors, June 20 12 SPIVA Scorecard
Reviewing all US equity funds against the broader S&P 1500 Index, 92% failed to beat the benchmark over the past year, with 85% and 76% failing over the past three and five year periods, respectively. The majority of US fund managers running global portfolios also underperformed their respective global index benchmarks. Over the past five years 84% of fund mangers failed to beat the Emerging Markets equity index, while 74% underperformed the global developed markets index outside the US. The turmoil of the past five years saw approximately 24% of US domestic equity funds being closed or merged out of existence. Similarly 22% of international funds closed as did 15% of fixed income funds.
% of US Bond M anagers underperforming the Index (June (June 30, 30, 2012) 2012) 1 1 year year
3 3 year year
5 5 year year
95.6% 95.6%
96.5% 96.5%
93.6% 93.6%
US US Inv Inv Grade Grade short short bonds bonds
59.8% 59.8%
65.0% 65.0%
93.8% 93.8%
High High Yield Yield Funds Funds
83.1% 83.1%
90.5% 90.5%
94.8% 94.8%
Global Global Income Income Funds Funds
61.2% 61.2%
46.8% 46.8%
65.1% 65.1%
Emerging Emerging Markets Markets
86.5% 86.5%
57.1% 57.1%
71.4% 71.4%
US US Gov Gov tt long long bonds bonds (v (vs. s. Barclays Barclays Long Long Gov Govtt))
(v (vs. s. Barclays Barclays 11--33 yr yr Gov Govtt/Credit) /Credit)
(v (vs. s. Barclays Barclays High High Yield) Yield)
((vvss Barclays Barclays Global Global Ag Aggregate) gregate)
(v (vs. s. Barclays Barclays Emerging Emerging Markets) Markets)
Source: Standard & Poors, June 2012 SPIVA Scorecard
Using index funds, the investor need have no concern whether the fund manager is fickle, nearing the end of a hot streak, or may move to another investment firm. When building a long-term investment portfolio, investors should begin to emulate many of the world’s most sophisticated investors. In the US approximately 37% of all pension fund assets are now invested in index funds. CALPERS the largest US pension fund commonly indexes over 30% of its almost $250bn portfolio. The index outperformance is largely due to the constant trading (churning) which occurs within most unit trust portfolios, in a mostly futile attempt to outperform the stock or bond markets. The high trading commissions and related fees most actively managed funds incur coupled with the narrow portfolio focus on only a limited number of stocks or bonds – usually ensures a weaker performance than the selected index benchmark.
Index funds incur few transaction charges from buying and selling different stocks. The typical mutual fund or active manager generates an extremely high turnover rate of 100% annually – most studies agree that this effectively burdens a unit trust with an additional 2.5%-3% of costs. By contract most index funds have an incredibly low annual portfolio turnover of between 5%-10%. Given the efficiency of markets and the lack of any dominant sector in broad market indexes – it is not surprising that the vast majority of fund managers struggle to beat their own benchmark indices. Those who list top-performing actively managed funds as evidence that indexing doesn’t work are in fact doing investors a terrible disservice. Although each year some active actively managed funds will always beat the indexes, few consistently do over a 5 year period because of style rotation and reversion to the mean. FOR MORE INFORMATION VISIT www.RVWinvesting.com