In the active versus passive debate among mutual funds, the persistence of above-average returns is a key measure of success.
“Demonstrating the ability to outperform peers repeatedly is the only proven way to differentiate a manager’s luck from skill,” according to the latest S&P Persistence Scorecard report written by Aye Soe, a senior director, and Ryan Poirer, a senior analyst.
The report found that few actively managed funds are able to demonstrate that distinction and remain at the top of their game over time.
Less than 3% of large-cap and mid-cap stock funds that placed in the top quartile of rankings as of September occupied that ranking two years later, according to the S&P scorecard.
The five-year performance rankings were even worse. Less than 1% of large-cap funds in the top quartile of performance remained there after five years, and that was the best performing category among all other market cap categories. No mid-cap, small-cap and multi-cap funds remained in the top quartile of performance after five years.
“An inverse relationship generally exists between the measurement time horizon and the ability of top-performing funds to maintain their status,” the report notes. In other words, the longer the time horizon, the less likely top-performing actively managed equity funds will continue to outperform their passive counterparts.
Even more disappointing was data showing that the best-performing equity funds — in the top quartile — are more likely to become the worst performing funds — in the bottom quartile — than vice versa.
Of the 428 equity funds in the bottom quartile, 18.7% moved to the top quartile over a five-year horizon, while 27.8% of funds in the top quartile moved to the bottom quartile during that same period.
Funds in the bottom quartile, however, were more likely than other funds to be merged or liquidated. Over the five-year period, 28% of large-cap funds, 24% of mid-cap funds and 30% of small-cap funds in the bottom quartile disappeared.
S&P also studied the performance persistence and longevity of 13 categories of fixed income funds (including three muni categories), and here the findings were much more favorable for actively managed funds.
In all but three categories, the percentage of top-quartile bond funds retaining that ranking over three years was in the double digits, led by government long funds (53% remained in the top quartile), followed by general municipal debt funds (45%), California muni funds (44%) and government intermediate bond funds (43%).
Top-tier general municipal debt funds, mortgage-backed securities funds and short-term investment grade funds were along the most volatile during the five-year period. About 50% of muni funds, 38% of mortgage-backed funds and 31% of short-term investment grade funds fell from the first quartile to the fourth quartile over that time period.
The top bond categories showing improved performance during that same time period, moving from the bottom quartile to the top quartile, were general muni bond funds (25%) and global income funds (15%).
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