Index tracker funds are an easy sell if investors are looking for lower cost, higher return options. That is demonstrated once again in the latest figures from the US, which show that 82% of US fund managers fail to beat their index benchmarks.
South African global index tracking pioneers Anthony Ginsberg and Lisa Segall illustrate in this piece, written specially for Biznews.com, that there really are very few investment professionals who can outwit the markets. Mostly, when we pay for a professional to manage our mutual fund investments, it seems that we are not getting value for money.
They also warn that investors tend to pull out of a fund after three bad years, effectively locking in losses. Yet these poorly performing funds have generally turned out to be the out-performers over a longer investment period – which means a little more patience would have been rewarded.
If you’ve ever pondered whether your money should be in an index tracker, this article offers compelling statistics that suggest it is the right place to be. – JC
By Anthony Ginsberg and Lisa Segall
Given the news of US equity indices hitting record highs, Vanguard just released a timely report* confirming that only a small minority of US fund managers outperform their equity index benchmarks. Over the past 15 years (1998-2012) the fate of 1540 actively managed US equity funds were examined. Vanguard’s study confirms that just 18% of US fund managers beat their equity index benchmark over this period. This covers large cap, mid cap and small cap mutual funds operated in the US.
Trying to identify the few US superstar portfolio managers ahead of time is truly akin to looking for a needle in a haystack and many would argue a fool’s errand! Given the difficulty of beating the US indices due to efficient markets, trading costs and expenses – it is not surprising that indexing has become increasingly mainstream. This is particularly for sophisticated investors who work with financial advisors as well as large US pension funds and institutions.
It is also noteworthy how many active funds were also terminated during this period – typically the worst performing funds are closed down! According to Vanguard, only 55% of active funds survived this entire period intact without being terminated or merged out of existence. Ultimately just 275 funds out of these 1540 total equity funds, not only survived but also beat their index benchmark. Even these winners endured long stretches of lagging their index benchmark – with 97% experiencing at least 5 calendar years in which they lagged. In fact only 6% of US fund managers not only survived, but also outperformed and avoided three consecutive years of underperformance. Put another way, two thirds of the outperforming funds experienced at least three consecutive years of underperformance.
For many investors three years of consecutive underperformance represents a breaking point after which they will typically divest from the fund manager – locking in weak returns.
The findings suggest that investors should refrain from using short-term performance as the primary criterion for divesting or investing in an active mutual fund. These findings back up recent studies by S&P indicating the vast majority of US fund managers fail to beat their US and global equity index benchmarks.
According to S&P’s recent SPIVA report for the 12 months ended June 30th, 2013 US active fund managers continued to lag behind their benchmark indices – with 59.6% of large cap funds underperforming the S&P 500, 68.9% of mid-cap funds performing below the S&P 400 and 64.3% of small cap funds losing to their S&P 600 benchmark. Over the past 3 years the percentage benchmark underperformance by managers is far worse – 86.0%, 85.8% and 80.2% respectively. Going back 5 years the underperformance remains overwhelming – 79.5%, 82.0% and 77.9% respectively.
US fund managers focusing on foreign markets also failed to beat their global benchmarks over the past year: 61.7% of global funds underperformed, followed by 54.8% of emerging market funds and 54.2% of international funds. Over the past 5 years the underperformance numbers are respectively: 62.6%, 74.5% and 65.9%.
US bond fund managers again struggled to beat their benchmarks, with over 80% of active bond mangers failing to beat the High Yield and Barclays Long Government indices, over the past 3 years. (83.5% and 96.7% respectively).
According to the S&P study, the volatility in global equity and bond markets over the past five years, led to the closure or merger of 27% of domestic US funds, 24% of international equity funds and almost 20% of bond funds.
Consequently for those investors keen on pursuing active fund management with the hope of achieving outperformance – it is important to note that to increase the odds of success, such investors must be able to endure numerous and potentially extended periods where their fund will lag its benchmark index.
*Vanguard 2013: The bumpy road to outperformance – Brian Wimmer
* Anthony Ginsberg and Lisa Segall are directors at GinsGlobal Index Funds.