Active mutual funds can’t measure up to indexes — again

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The trouble with news reporting is that when something is no longer new, it’s no longer news.

That means we don’t hear about it.

I haven’t seen a single report, for instance, pointing out that the number of deaths due to COVID-19 is similar to the number of deaths due to smoking over the same period. According to Google News, 1,006,566 Americans had died from the virus since it was first reported in January 2020, some 29 months ago.

Yet, according to the Centers for Disease Control and Prevention, about 480,000 Americans die each year as a result of smoking. Over a two-year period that would be 960,000. And if we added the additional 200,000 who would have died between January and May, the deaths due to smoking would total 1,160,000.

One cause of death, however, is new. The other is really old.

This kind of unbalanced reporting isn’t limited to health. It’s pretty much universal. A recent case in the world of investing is the publication of the semiannual SPIVA report.

Oh, you missed it?

That’s no surprise. It was barely noted in the press.

Yet this report, now with 20 years of data, tells us something that every investor should know. The Standard and Poor’s Index Versus Active report assiduously examines the proportion of actively managed mutual funds that have managed to beat the index by which they are measured.

The report has found, year after year, that the majority of managed mutual funds — you know, the ones with extremely well-paid managers who like to claim profound skill and deep insight — fail to beat the index that describes the area in which their fund invests.

We’re not talking a coin toss here. We’re talking wipe-out.

The most recent report tells us that the darlings of recent years, the growth fund managers, utterly failed to beat the S&P 500 Growth index in 2021. By utterly, I mean 98.6% of them.

That should tell us something.

Worse, the longer the investment period, the greater the failure rate. While only 72% of all domestic managed equity funds underperformed the S&P 1500 Composite index over the past three years, 86% failed over 10 years and 90% failed over 20 years. The fail rate for international funds is almost as bad. Ditto, fixed-income funds.

As a result, our tendency to put a high value on recent figures can lead us to believe that management has a shot at earning its keep. It’s a very bad bet. Only 38.46% of large-cap value funds, for instance, underperformed their index in 2021. But over the past 10 years, 89% failed. Similarly, while only 9.4% of investment-grade long-term bond funds failed to beat their index in 2021, a whopping 98% failed over the past 10 years.

The single largest reason that managed funds show up so poorly in the SPIVA studies is something called “survivor bias.” While services like Morningstar routinely rank funds that still exist, those figures ignore the number of funds that existed three, five or 10 years ago but have been quietly merged with another fund or simply buried in an unmarked grave.

The report notes, for instance, that about 5% of funds in all categories “were merged or liquidated” in 2021. The fatality rate is much higher over longer periods. Nearly 70% of all domestic equity funds and 66% of all international funds disappeared over the past 20 years. And, yes, it’s pretty much the same for fixed-income funds. It’s also important to note that the past 20 years wasn’t exactly smooth sailing. Yet “buy and hold” beat the fancy folks.

One implication in these figures is that most index funds are actually beating more managed funds than indicated in their Morningstar reports. Vanguard Total Stock Market Index ETF, for instance, ranked at the 26th percentile over the 10 years ending March 31, according to Morningstar. But only 62% of large-cap or all domestic funds survived over the period. Adjusting for survivor bias, Vanguard Total Stock Market Index ETF was actually in the top 16%, beating 84% of the competition that started the 10-year period.

This doesn’t mean, by the way, that you should ignore Morningstar reports. They are sliced bread for you and me. It just means that if index funds look good in those reports, which they almost always do, you can be certain that their actual performance against managed choices is even better.

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