The Active V Passive Investing Debate by TPP.

More on the ‘Active vs Passive’ Debate

This year, the SPIVA scorecard comes of age. For 21 years it’s been the go-to report for investors and others interested in the ‘active vs. passive’ debate. With more than two decades of data to refer to, let’s look at what we can learn from these reports.

What is SPIVA?

SPIVA stands for ‘S&P Indices versus Active’ and reports are published by a division of S&P Global. Their primary purpose is to inform on the ‘active vs. passive’ debate by providing data on how actively managed funds around the world have performed, over both the long and the short term, against the appropriate benchmarks.

The two main reports that are produced are:

The SPIVA Scorecards – provide data on the performance of active funds against relevant benchmarks. Reports are provided for markets around the world, both equity markets and fixed-income markets. They are broken down into categories according to the type of fund, to ensure the appropriate benchmark is used – for example, large, mid or small-cap funds.

The SPIVA Persistence Scorecards – measure the consistency of a fund’s performance relative to its peers. In other words – are funds that outperform in a given period able to maintain that outperformance in subsequent periods? This Scorecard is designed to address the question of whether outperformance is the result of skill (in which case outperformance would be expected to persist over time) or luck (in which case outperformance would be expected to be more random).

What do the results tell us?

The SPIVA data tells a remarkably consistent story.

According to Craig Lazzara, Managing Director, Core Product Management S&P Dow Jones Indices: “Our very first SPIVA Scorecard reported that most active managers had underperformed a benchmark appropriate to their investment style over a full market cycle. Our most recent SPIVA update reports more or less the same thing.”

The first SPIVA Report covered the US equity market only, but more recent data from Indices around the world tells a similar story. The chart below shows the percentage of large-cap US equity funds underperforming the S&P 500 each year since then.

Percentage of Large-Cap Domestic Equity Funds Underperforming the S&P 500 Each Year

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Source: S&P Dow Jones Indices LLC. Data as of 30 June 2023. The chart is provided for illustrative purposes. Past performance is not indicative of future performance.

Since the first report, SPIVA has expanded to nine different geographies and now reports on the performance of over 100 different active fund categories around the world.

A consistent theme of SPIVA Scorecards over the years has been that underperformance rates generally rose with the length of the period in which performance was measured.

The table below shows the percentage of active Australian and US equity funds that have underperformed their relevant benchmark.

Source: https://www.spglobal.com/spdji/en/research-insights/spiva/. US Large Cap Funds are compared to the S&P 500 Index. Past performance is not indicative of future performance.

In Europe the results are similar.

Over a five-year horizon, it was statistically nearly impossible to find funds that consistently remained in the top performance quartile year after year. Of the 1,118 actively managed funds whose performance over the 12-month period ending December 2019 placed them in the top quartile in their respective categories, just two funds remained in the top quartile in each of the four subsequent one-year periods ending December 2023.

Over discrete five-year periods, there were also few funds whose relative outperformance persisted. Just 17% of top-half U.K. Equity funds remained in the top half for two consecutive five-year periods,

Good luck or good management?

The disclaimer “Past performance is no guarantee of future performance” is included in the material on all funds offered to investors (including our own); but if you can’t go off past performance, what else is there? However, what this is basically telling potential investors is just because a fund, or fund manager, has produced good results in the past, this doesn’t necessarily mean they will do so in the future

With index tracking funds, there is no decision to be made around the ‘skill’ of the fund manager, as the manager is simply aiming to replicate the performance of the index (before fees and expenses). If the index does well, so too does the fund, if the index performs poorly so too does the fund. The lack of activity makes them cheaper. This is true on TPP where our leveraged trackers are only £65 a month. They do still require managing, but it is less active than our other strategies which is why they cost a little less.

This is not the case with the active fund manager, who typically aims to do better than the index – and in doing so, justify their active management fee.

So – what does the data tell us?

The SPIVA Persistence Scorecards show the percentage of funds that remain in the top-quartile or top-half rankings over consecutive three- and five-year periods.

The US Persistence Scorecard Year-End 2022 found that of 2020’s top quartile large-cap funds, none continued in the top quartile for the next two years and only 5% of the above-median large-cap active equity funds in calendar year 2020 remained above median in each of the two succeeding years.

The report also looked at the top 50% of domestic equity funds in the 12 months ending 30 December 2018, and their performance over the subsequent three years. It found that among all domestic equity funds, there was a 0% chance of a top-half performer, as of 31 December 2018, still being a top-half performer as of 31 December 2022.

Performance Persistence of US Domestic Equity Funds over Three Consecutive 12-Month Periods

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Source: S&P Dow Jones Indices LLC, CRSP. Data as of December 31, 2022. The chart is provided for illustrative purposes. Past performance is not indicative of future performance.

How do investors see the active/passive question?

It’s impossible to know how many investors have been influenced by the data presented by SPIVA over the last two decades. However, what is unarguable is that investors are increasingly favouring passive exposures over active ones.

The chart below shows cumulative US fund flows from 2000 to August 2022 into active and passive funds. Since 2014/5, it’s clear that money has been pouring into passive funds.

The chart below shows historical fund assets in US funds from 1993 to into active and passive funds.

Historical Fund Assets: Active vs. Passive

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This trend has continued and at the end of December 2023, passive US mutual funds and ETFs held about £13.3 trillion in assets while active mutual funds and ETFs held just over $13.2 trillion – according to data released by Morningstar.

On net, active funds shed about $450 billion last year, passive funds took in about $450 billion.

One noticeable change is that hedge funds and platforms like TPP are using index strategies within their portfolios due to their simplicity and speed. If one of our traders wants to buy the US market, it’s simpler to buy the S&P 500 as a whole than it is to work out which particular stocks they want to buy.

The same goes for selling. ETFs and Futures have made this incredibly simple to do. Most hedge funds will hold an ‘Emerging Markets’ ETF or future rather than look at which emerging markets they like the most. Having all-round exposure to sectors, countries, blocks of countries etc. has never been simpler – for those who know how to use them.

If you want to buy the index and track the S&P 500 rather than pay your investment manager their inflated fees, then are you an investor who would rather buy the index with a touch of leverage? If you want to invest in the S&P 500, TPP has now built a product where you can do this with 1.5x the market movement.

By this we mean if you invest £50,00 in the S&P 500 and the index moves 10% over the year, your investment of £50,000 would move at 15%. Over time, with compound returns the results of this are remarkable.

£50,000 earning 10% over 20 years = £366,403.68

£50,000 earning 15% over 20 years = £985,774,68

* Interest has been compounded monthly in this example. It has been used for illustrative purposes. Past performance is not indicative of future performance.

As you can see, over time, the increased level of returns makes a much larger difference than you would expect and it’s one that should not be ignored.

If you have any questions about our trackers or any of our other actively traded strategies, please do not hesitate to contact us. Our platform was designed to build portfolios for the future.

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At TPP we have 3 tactics that we employ to consistently beat our market benchmarks for your portfolios. Our leveraged trackers are becoming more and more popular as investors look to build the foundations of a market-beating portfolio. There are no ifs or no buts. These deliver 1.5 x market benchmark performance.

Our second tactic is our 'long (buy) or flats' which similar to the trackers will predominantly be on the long/buy side of the market and will occasionally move into a flat/market neutral position when the markets look overbought. They wait patiently for a retracement, and move back into the market when the opportunity arises.

Finally, we have our active equity long/short strategies, that provide a more aggressive edge to one's portfolio. Collectively, we hope we can assist you to build a diversified portfolio that consistently beats your market benchmark.

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TPP: The new way to invest.

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