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Portfolio > Mutual Funds > Equity Funds

The Persistent Underperformance of Actively Managed Funds

By Bernice Napach

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As the ETF market prepares for a likely influx of new actively managed funds ETF following SEC approval of a nontransparent actively managed ETF strategy, financial advisors may want to consider the repeated underperformance of actively managed mutual funds.

According to the latest Persistence Scorecard from S&P Dow Jones Indices, few actively managed mutual funds consistently placed in the top performance quartile over three consecutive 12-month periods and even less performed as well over five consecutive 12-month periods.

(Related: Financial Advisors Can’t Wait for Nontransparent Active ETFs: Survey)

The latest scorecard, covering the six months through March 2019, found that just over 11% of actively managed U.S. equity funds remained in the top quartile three years later while less than 1% stayed there after five years.

Small-cap equity funds fared best, with just over 23% placing in the top quartile over three years. Large-cap stock funds performed worst — less than 6% scored in the top quartile over three years. In between those two extremes were mid-cap and multi-cap equity funds, with roughly 14% and 13%, respectively, remaining in the top quartile over three years.

Persistent performance for all U.S. equity fund categories over five consecutive 12-month periods was virtually nonexistent. Only small-cap funds scored above zero for the percentage of funds remaining in the top quartile, but that number was below 1%.

Bond funds showed more staying power than stock funds, but fewer than one-quarter remained in the top quartile over three consecutive 12-month periods and almost none stayed in the top quarter over five consecutive 12-month periods.

“A turnaround in the bond market’s outlook appeared to wrong-foot many top quartile fixed income managers,” according to the report. Many managers expected interest rates would rise but the reverse occurred.

The best performing category among bond funds were mortgage-backed securities funds. Close to 40% remained in the top quartile after three years but that did not persist over the five-year period. Zero mortgage-backed securities funds continued in the top quartile over five years, as did most actively managed bond fund categories. The best-performing exception — there were only two — was general muni debt funds. Close to 11% remained in the top quartile after five years.

Another finding from the Persistence Scorecard report drives home even more forcefully the adage that past performance is no guarantee of future results: “top-performing funds were more likely to become the worst performing funds than vice versa over the five-year horizon.”

Almost 32% of top-quartile funds moved to the bottom quartile over five consecutive 12-month periods while slightly less than half (15.3%) moved from the bottom quartile to the top.

“Our latest persistence scorecard shows just how challenging it has been for managers to consistently beat their peers, especially over longer horizons when market environments are more likely to change and competitors may become wise to (relatively) successful strategies,” writes Hamish Preston, associate director of  global research & design, at S&P Dow Jones Indices.

— Check out How Top Asset Managers Stay Ahead of the Pack on ThinkAdvisor.

Bernice Napach

@Think_Napach

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