The Active vs. Passive Debate

The debate between active management and passive management has being ongoing for several years. Active managers make investment decisions in an effort to outperform their benchmark, while passive managers simply track an index to gain exposure to a market or segment of a market. Active managers claim to have enough skills to consistently outperform the market, but do they really beat their benchmarks?

SPIVA®, which stands for S&P Indices versus Active, reports on the performance of actively managed funds against their respective category benchmarks, such as the S&P 500® in the U.S. and the S&P/BMV IPC here in Mexico. The results are impressive and consistent across the world: indices tend to outperform the majority of actively managed funds, mainly over the over the mid- to long-term investment horizons.

The SPIVA Latin America Mid-Year 2019 Scorecard showed that over the one-year period ending on June 30, 2019, 64% of actively managed funds in Mexico underperformed the S&P/BMV IRT, the total return version of the flagship S&P/BMV IPC. In addition, the percentage of active funds underperforming the benchmark increased over longer-term investment horizons; 82%, 90%, and 86% of active managers were not able to beat their benchmark over the 3-, 5-, and 10-year horizons, respectively. One should notice that active fund managers do not always lag the benchmarks, especially over the short-term horizons. A clear example was in the year-end 2018 report, when more than 58% of Mexican active funds outperformed the S&P/BMV IRT. The numbers suggest that active managers’ outperformance relative to the benchmark may exist, but rarely.

Furthermore, it is challenging for managers to consistently remain at the top of their categories, especially over longer horizons. The Latin America Persistence Scorecard demonstrates that top-performing active funds have little chance of repeating that success in subsequent years.

The SPIVA report does not intend to explain why underperformance exists, rather it is meant to act as a scorekeeper. That said, we could argue that many active managers do not have the skill to beat their benchmarks consistently that they may claim to have. It is difficult to time the market with consistent success, and the trading costs associated with excessive trading from active managers does not help fund performance. Furthermore, SPIVA uses net-of-fees returns of active funds, and numerous studies[1] show that the fee drag in fund returns can be substantial.

SPIVA can help investors make informed decisions about whether to use an active manager or invest in an index-based fund such as an ETF. It also reminds investors that using past performance as the main guidance in fund selection could be misleading due to the lack of performance persistence among actively managed equity funds.

This article was first published in Fortune Mexico Magazine December 2019.

[1] Sharpe, William F., “The Arithmetic of Active Management,” Financial Analysts Journal, January/February 1991, Volume 47 Issue 1. “Properly measured, the average actively managed dollar must underperform the average passively managed dollar, net of costs.”