More Evidence That Passive Beats Active Among Mutual Funds

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.