Is it best to pick a mutual fund run by a top-notch manager? Or should you keep expenses low and track an index? Determining which side of the active vs. passive debate you’re on is an important part of the investment planning process.
Passively-managed investments track indexes like the S&P 500. These types of funds replicate the holdings of an index in an attempt to track its performance as closely as possible. Actively-managed investments attempt to outperform their respective index by making active decisions about which securities to hold, when to get in and out of the market, etc.
Early on I was a firm believer in active management. After all, why would I limit myself to being “average” by buying an index fund when I could pick a manager that had a chance of beating it? One problem I noticed was that the index-smashing performance that my mutual funds earned before I invested in them didn’t always continue.
One of my favorite sources of information on the active vs. passive debate is the S&P Indices Versus Active (SPIVA) report. SPIVA reports compare all actively managed funds against their respective benchmarks. I like SPIVA reports because they account for survivorship bias, which refers to the tendency for mutual funds with poor performance records to be closed or merged into other funds.
The first mutual fund I ever purchased, the Babson Value Fund, began to perform poorly a few years after I purchased it and was eventually merged into another fund. Although you can track down its performance history if you look for it, these numbers aren’t automatically included in mutual fund performance reports.
Closing underperforming funds – and removing the poor performance history from the databases used to calculate mutual fund performance – makes the performance of the remaining mutual funds look better than it otherwise would. By including the performance records of closed funds, the SPIVA reports provide a better comparison of the performance of active managers against their respective benchmarks.
Percentage of Actively-Managed Funds Underperforming Benchmark (Year-End 2015)
| Fund Category | Benchmark Index | Three-Year | Five-Year | Ten-Year |
| All Large-Cap Funds | S&P 500 | 75.8% | 84.2% | 82.1% |
| All Mid-Cap Funds | S&P MidCap 400 | 61.6% | 76.7% | 87.6% |
| All Small-Cap Funds | S&P SmallCap 600 | 81.7% | 90.1% | 88.4% |
The information in the table above comes from the year-end 2015 SPIVA report.
Over the past 10 years, an average of 82.1% of large-cap fund, 87.6% of mid-cap funds, and 88.4% of small-cap funds failed to beat their respective benchmark. Interestingly, the odds against picking a “winning” fund were higher in the small- and mid-cap arena where many people assume that active managers have an edge since these stocks aren’t as heavily researched as large-cap stocks
Some investors argue that an actively-managed fund will be able to outperform during a bear market since the manager can move to cash during a downturn. Index funds, on the other hand, have to remain fully invested even when the market is declining.
The SPIVA report showed that actively-managed funds didn’t perform as well as many expected during the last two market downturns. When looking at all actively-managed large-, mid-, and small-cap funds, the SPIVA report found that anywhere from 54.3% to 83.8% were outperformed by their respective index during the 2000-2002 and 2008 bear markets.
Percentage of Actively-Managed Funds Underperforming Benchmark During a Bear Market
| Fund Category | Benchmark Index | % Underperforming
(’00-’02 Bear Market) |
% Underperforming
(’08 Bear Market) |
| Large-Cap Funds | S&P 500 | 53.5% | 54.3% |
| Mid-Cap Funds | S&P MidCap 400 | 77.3% | 74.7% |
| Small-Cap Funds | S&P SmallCap 600 | 71.6% | 83.8% |
The information in the table comes from the year-end 2011 SPIVA report.
I’ve been reading SPIVA reports for years and the results are fairly consistent. Although considered boring by many and often ridiculed by many investment pros, index funds are one of the best investment vehicles for individual investors. In fact, institutional investors had been using index-type investments for years before the first index fund for individual investors, the Vanguard 500 Index Fund, was introduced by John Bogle in 1976.