Which mutual fund achieves an annual growth of 17

In the long term, active funds lag behind their markets

Quantitative analyzes confirm time and again that very few actively managed investment funds manage to achieve better long-term performance than the markets in which they operate. This is also confirmed by the latest calculation by the index provider S&P Dow Jones Indices: In the past 15 years, more than 80 percent of all active funds have outperformed their benchmark indices.

“Smart investors don't try to beat the market, they buy long-term index funds and diversify,” is an important piece of advice that John Bogle gave to long-term investors. Admittedly, Bogle, who died in 2019, was not a neutral market observer. He is considered one of the inventors of index funds and was managing director of the US fund company Vanguard for many years, which is still one of the most important providers of this type of fund today. However, for some years now, independent scientists and research companies have also published numerous studies on the performance of index funds. Their results show again and again: the man was right.

Active funds better than passive benchmark indices

A good example are the analyzes by the research and index provider S&P Dow Jones Indices, which has been comparing the performance of active retail funds with those of matching market indices on a regular basis since 2002. It was only in mid-November 2019 that the company published its semi-annual report for the USA, by far the largest and most important fund market in the world. The comparisons over ten and 15 years are particularly interesting because they are relevant for long-term investors. Some important results of the latest study: Just over twelve percent of all 1,929 actively managed mutual funds with an investment focus on US stocks that were on the market in the USA in the summer of 2004 performed better than the corresponding market indices at the end of June 2019 . While the funds gained an average of almost 7.5 percent per year during this period, the benchmark index S&P Composite 1500 rose by almost 8.9 percent annually.

Few US funds beat their benchmarks over the long term

S&P Dow Jones calculates these numbers for different categories of active equity funds. It is noticeable that the fund manager's balance sheet hardly differs in these categories over 15 years. Regardless of whether the investment focus is on US standard stocks (89.8 percent of all funds performed worse than their benchmark index), US small caps (90.3 percent), growth stocks of various sizes (90.4 percent) or real estate stocks (83.3 percent) is: The performance of most funds lagged behind their benchmarks. Even 94.3 percent of the emerging market equity funds marketed in the USA performed worse than their benchmark index in the 15-year period under review. Given their inefficiency, these markets are considered to be the ideal environment for active investment strategies. Even with bond funds, the long-term balance sheet of active funds does not usually look better: For example, 91.1 percent of all funds that invest in US government bonds with medium-term maturities performed worse than the benchmark index. The picture is surprisingly uniform: in almost every single fund category, at least 80 percent of all active funds performed worse than their respective reference indices in a 15-year comparison.

Conclusion for investors

But what do these somewhat abstract numbers mean for investors? A specific example helps to illustrate this: Let us assume that an investor in the USA wanted to invest long-term in an actively managed investment fund with an investment focus on US standard stocks in the summer of 2004. At that time, he could theoretically have made a selection from 660 different funds. At the end of June 2019, only 67 of these funds had outperformed the S&P 500 Index, which contains the stocks of 500 leading US companies, over the full 15 years. An impressive 394 of the 660 funds were no longer on the market in mid-2019 because they had been dissolved or merged with other funds.

These long-term results change only slightly over time: in older analyzes, the data for 15 years hardly differ from those from the study mentioned. There are only major fluctuations in comparisons over short periods of time or individual calendar years. There are always years in which, in certain fund categories, even more than half of all active funds have outperformed their benchmarks. The media are happy to pick up on such short-term developments for understandable reasons. However, they are interesting for speculators at best. Such snapshots do not help long-term investors.

In Europe too, most active funds do poorly over the long term

S&P Dow Jones also prepares corresponding analyzes for other fund markets. The most recent report for the European market is from April 2019 and compares active funds based on data at the end of 2018. It does not yet contain results for 15 years, but the figures for ten years paint a very similar picture to the US funds: In nine of eleven categories of equity funds issued in euros, more than 80 percent of the funds achieved a poorer performance than their benchmarks during the ten years under review. The figures were only slightly better for funds with an investment focus on Italian and Spanish stocks.

For example, of a total of 1,425 funds launched in euros with an investment focus on global stocks that were on the market at the beginning of 2009, only 22 survived the following ten years and achieved better performance than the corresponding benchmark index. In most of the other fund categories, the balance sheet is not much better: Only 183 of 1,402 funds with an investment focus on European stocks, 68 of 781 equity funds with a focus on the euro area and 20 of the 113 funds with a focus on German stocks survived the ten years and were there outperformed its respective benchmark index.

Why is survivorship bias important?

In such long-term analyzes, it is important to also include funds that were dissolved or merged with other funds during the period under review. Why? Let's take an example: of the 113 Germany equity funds at the beginning of 2009, 63 were still on the market at the end of 2018. If the share of the 20 outperformers were only related to these funds, it would be around 32 percent. That would be almost a third. However, this number is irrelevant to investors. Because it does not reflect the situation in which an investor actually found himself at the beginning of 2009: at that time he could choose from 113 German funds. Investors could not have known that only 20 of them achieved better performance than their benchmark in the following ten years. From this perspective, which is crucial for investors, the proportion of outperformers is just under 18 percent. Distortions that emerge when analyzing only the surviving funds are called “survivorship bias” in technical jargon. Serious long-term analyzes should take this bias into account and correct it.

For the sake of completeness, it should be mentioned that other independent research companies are now also publishing similar analyzes. Despite certain differences in the methods and in the choice of reference indices, however, they get similar results in the long-term performance comparisons: According to a current analysis by Morningstar for the fund markets in German-speaking countries (DACH region), for example, at the end of 2019 only 17 percent of all equity funds and 15 percent of all bond funds survived the previous 15 years and outperformed their benchmark indices.

What conclusions can investors draw from these numbers?

There are intense and sometimes controversial discussions about the reasons for this disappointing long-term balance sheet of active investment funds. It is almost certain that the relatively high costs of active funds are a major cause of their poor performance. However, the analyzes by S&P Dow Jones presented here do not allow any corresponding conclusions.

Since there is no reason to believe that active funds' track records will improve significantly over the next 15 years, there are two alternatives for long-term investors:

  1. You're trying to find the needle in the haystack. Because you have to choose one from hundreds or even thousands of the active investment funds on offer that could achieve long-term outperformance in the future. It should be clear that this is not so easy because the funds do not have a “I am an outperformer” sign.
  2. You stick with Bogle, forego the small chance of outperformance and instead invest in an index fund.

Keep it up with Bogle

Option 2 is not only much simpler, but also offers another important advantage: with an index fund that tracks a specific stock or bond market as precisely as possible, investors have a good chance of achieving better performance than 80 percent in the next ten or 15 years of all funds that pursue active investment strategies in this market. Index funds are therefore a very interesting instrument for long-term investors in particular to invest their money in stock and bond markets.

At Whitebox we do not use actively managed mutual funds. We implement our long-term investment strategy primarily with exchange-traded index funds (ETF = exchange traded funds), which we combine in different, well-diversified portfolios. The long-term performance of active funds, which is often below the market average, is not the only and also not the most important reason for this decision (see also “How Whitebox works with ETFs”). However, analyzes such as those by S&P Dow Jones or Morningstar help us to feel comfortable with our decision.