SUMMARY
Risk and return are two sides of the same coin. Beyond relative performance of funds, market participants are also interested in the risks taken to achieve those returns. This motivated us to examine the performance of actively managed funds on a risk-adjusted basis.
The Risk-Adjusted SPIVA Scorecard measures the performance of actively managed funds against their benchmarks on a risk-adjusted basis, using net-of-fees and gross-of-fees returns. We use return/volatility ratios to evaluate performance. Volatility is computed by taking the standard deviation of monthly returns. Our goal is to establish whether actively managed funds are better at risk management than passive indices, using net-of-fees and gross-of-fees returns.
After adjusting for risk, the majority of actively managed domestic funds in all categories underperformed their benchmarks, on a net-of- fees basis, over mid- and long-term investment horizons.
Although the risk-adjusted performance of active funds improved compared with their benchmarks on a gross-of-fees basis, real estate funds (over the five-year period) was the only category that generated a higher ratio than the benchmark. Overall, most active domestic equity managers in most categories underperformed their benchmarks, on a gross-of-fees basis.
The majority of international equity funds also generated lower risk-adjusted returns than their benchmarks, when using net-of-fees returns. International Small-Cap Funds were the only category that outperformed the benchmark on a risk-adjusted basis over the 10-year period, on a gross-of-fees basis.
When using net-of-fees returns, the majority of actively managed fixed income funds underperformed across all three investment horizons on a risk-adjusted basis. The exceptions were Investment-Grade Long Funds and Loan Participation Funds (over the 5- and 10-year periods), as well as Government Long Funds and California Municipal Debt Funds (over the 10-year period).
Unlike their equity counterparts, most fixed income funds outperformed their respecitve benchmarks gross of fees. This highlights how the role of fees in fixed income fund performance was especially critical. More active fixed income managers underperformed the benchmark on a risk- adjusted basis over the long term (15 years) than in the intermediate term (5 years).
Asset-weighted return/risk ratios of active managers were higher than the equal-weighted ratios, indicating that larger firms have taken on better-compensated risk than smaller ones. When comparing average ratios against their benchmarks, all domestic equity categories had lower ratios over all investment horizons when they were equally weighted on a net-of-fees basis. However, asset-weighted ratios of Real Estate Funds (over the 5-, 10-, and 15-year periods), Large-Cap Value Funds (over the 10- and 15-year periods), Mid-Cap Growth Funds (over the 5-year period), and Mid- Cap Value Funds (over the 10-year period) were higher than the benchmarks.
Looking at gross-of-fees versus net-of-fees returns, most fund categories produced higher return/risk ratios than their benchmarks if they were asset-weighted on a gross-of-fees basis. However, their outperformance diminished quickly once fees were accounted for, especially in domestic equity and international equity funds.
