The Active vs Passive Scorecard

who is an et F industry veteran. His SMP now and what he's bringing to us and where we're talking to him today is the SPEVA Report. For nerds know exactly what I just said, but if you don't, it's the SMP Index versus Active Report. It's a scorecard that says how will our active managers doing versus their benchmarks. This report has been out Tim make correct fifteen years and has been pretty instrumental in sort of driving the narrative and thus the flows towards passive because the numbers

are pretty bad. Okay, so we're gonna hear from Tim Edwards of SMP this timeand trillions the SPIVA Report. Tim wakan a trillions. Hi, thanks very much for having me. Okay, Tim Spiver. For those not familiar, what is this going to reveal? Well, it was in fact first published twenty years ago that Chack the good Time Flies. The concept

is is really really simple. Um. The idea is to take a database of actively managed funds, assign each fund correctly to a representative benchmark, so if it's a large cap us equity fund, the sp and then on a regular basis to report how many of those funds survived, survived and beat the benchmark. And then there's a wealth of additional data around the spread in performance average performance across funds, both over the short term and over the

long term. So it's a report that gives you a sense of where active management is doing really well different geographies, different market segments. What the long term statistics tell us about where indexing might work as an investment strategy. Okay, so who's winning? Who's writing? Um? Well, we just today published our latest edition of the spever U score cord Um.

It runs data up to the media point of two and unusually perhaps um, it's really really close year to date in two of actively managed US large cap funds underperformed the SMP five dred So it's not it's not exactly fifty fifty's before, but essentially it's it's a coin flip. So in the short term I'd say that it's a really close race for two. Over the long term, a much higher proportion of actively managed funds have underperformed the s Yeah, I mean fifty percent is a huge feed

for active there. When I think of active, especially in the large cap space, I think of like a third outperforming right this year half have So that's pretty good, is it? Because of the violatility, I think, I think there's a combination of factors. Um. So, there is traditionally a conception that active managers tend to do better in bear markets, and of course that's something that happened this year, and in the first half of the year, the US exty market turned from from boll to bear. Um the

data suggests a much more nuanced picture. Actually, a downturn tends to make things a lot more noisy and a bit more random. What we also saw this year, as well as slightly higher volatility, was a massive increase in dispersion, which is a measure of how differently stocks are performing. This was most visible in the performance of of different sectors. So energy doing fantastically well at the same time this

technology was doing rather badly. And what you had across different styles, across different sectors, across different stocks was a really big difference between if you like winners and losers. What what that does? It doesn't make any sort of strategy smarter, but it does really turn it into more of a game of luck rather than skill. Um. The last time we saw a dispersion as high as we've seen it so far in twenty two was two thousand and nine. Funnily enough, that's the last time that active

managers had such a good record. Yeah, I mean, um, I remember going back in two thousand and eight and looking at the twenty biggest active funds, and I found two thirds of them underperformed the horrendous year. Like the SMP was down, two thirds were down worse. And this was part of our big theme that we've been saying for I don't know a decade. At this point we're pretty proven, right, is that a bear market is actually

not going to help active um. It's it made help a couple of funds, but generally speaking, the same amount will outperform and the same amount will underperform um And the other thing I think just a bear market tends to be when investors flee their funds and their assets go down anyway, So it's just generally not they sort of.

I don't know the turnaround opportunity that I think people think it is, although if they can keep up fifty for the year or a couple of years, that I guess they would go a little further with maybe changing the narrative. Yeah, I think if if if they can maintain that that rate over the long term, then it does get to be more of a balanced picture. I mean, you know, something to bear in mind is we don't apply any due diligence, if you like, on when producing

our speed reports. We don't say how did the good funds? Do? You know? How do the funds that I would judge as being likely to outperform do? Instead? It's it's really about measuring the universe. So you might think, as an investor, oh, well, you know, overall half of the funds out performed, but I might be able to identify it half. That's the problem. This is the problem for active and why I don't

even know if it matters. Okay, fifty out perform, let's just say they actually held that up for five years. They won't, but let's just say they did. Most people, I think, especially advisors, have just sort of resigned themselves to going well. I I admit some will outperform, but I don't know which one is ahead of time, and I don't want to roll the dice on that. I'll just go Vanguard and buy a three basis point beta fund. And that's what the flow show. So I mean, can

active turn around at all? Is there? I mean? Is it over? Um? Well, let me say two things about that would say not. First of all, that's well no, it's the persistence problem too, and they if they do it one year, they usually or five year period, they usually do not do it the next five year period. And and advisors know this. This information is now out there thanks to Spiva and the Internet and whatnot. And obviously Vanguard and Bogel beat the drum on this for

many years. Um. I mean I'm not I'm I'm torn on how these tim tim is the game over? Well, first of all, let's just put some data around this conversation. So we mentioned under performing year to day in two, but the Spever reports to include longer term statistics. If you look at three years, that number goes up to under performing, If you go to ten years, that number goes up to under performing, and if you go out to twenty years since we've started producing these reports, it

is actively managed under performing UM so. So so that's the challenge I think that Eric's getting at right that the short term number is it's always be the long term number UM. Then you have the issue with as you say, persistence so UM. There are lots of different ways that you could try and identify a manager who's UM your well positioned to to beat the market. One of the challenges is the data suggests that the most obvious thing to look at, did this manager beat the market?

Historically UM tends to be a low information signal, So that's something that we cover in our Persistence report, which is a separate Spever report comes out similarly on a semi annual schedule, and what we look at is did the funds that used to beat the market or used to be their pays continue to do so? And there you find actually there's a there's a degree of reversion to the mean. It's really interesting to think about the

mechanics as to what happens to successful managers. That means that you know, they might be challenged in their future out performance. What the data says is that it is difficult to identify a fund that will win based on those that have outperformed in the past. Morning Star has this great report, uh like yours, but they put fee buckets into it, and what they find is there's a high correlation between the ones that do outperform um and

the and the ones that are cheapest. So the lowest quartile fee has a much better our performance rate than the highest quartile fee, which is almost like they all underperform. Is that kind of a common thread with the let's look at the tenure the ten percent or nine percent that outperformed. Is low fee a common thread or is there something else they haven't in common? So we um I've seen in the morning Star report and I like it,

and it probably is. Now I should emphasize what we do with SPEVER is to compare actively manage funds net of fees to benchmarks, which by convention do not include any trading costs. Right, So we're giving them a hard benchmark to be um. Over the years, we've heard this, you know, is it all about fees and so on, And so we started producing a different report which was published exactly a week ago, which looks at grosser fee performance and also looks at the performance of institutional accounts.

That's called spever institutional. And what that does is is answers first of all, the question of how much difference do fees make UM and what difference would it make if I had institutional resources devoted to selecting an outperforming active manager, and to take a just abroad look at the results, what you see is, first of all, fees do matter. Second of all, actually the performance of those institutionally managed accounts is slightly better than the performance of

mutual funds. However, most active funds underperform the benchmark, so even even gross of film. You know why you know, I again my study of Bogel and this book. I he would describe the active managers as sitting in a circle, and they're all trading with each other, like at a poker table. And I think sometimes people think of the stock market as something else, but it's really just a

bunch of people trading with each other. And for for me to win, Joel has to lose, and then I have to basically find losers, like four or five times in a row to be that that person who have performs, and the odds are tough. It's just very difficult to sort of gamble your way into having more money than everybody else. I guess a couple do it, but largely that everybody's sort of netting out zero plus you added the fees and then it's overall people. It's not quite

a zero some game. I think it's it's um. So here's here's the thing. We could all invest in the equity markets and we could all make money. It's not zero sum. What really is zero sum is is outperformance is being smarter than than than everyone else or than well exactly. The capital markets will build money, right, if you just put your money in there, it will grow. It's more of the outperformance zero some the trading. But I mean, here's one question I have in the in

the equity and we'll go to some other categories. I mean, all the numbers are pretty bad here, but you know, it seems to me that some of these funds were like built in the seventies, eighties, and nineties, and they have to be real close to the SMP, and it's tough to beat the SMP when you're close to it, whereas some funds now like an ARC, they go way out there and they're either gonna like crush it or get crushed, and seems to be investors sort of prefer

that because in the core they're moving to passive. Before you answer that, though, I think it's important that we talked about this universe of funds in general, right because this is everything. It's e T s, mutual funds, everything grouped up and evaluated as one. Yes, so ets are included on a report, but it's it's basically and did you break them out at all? Or is it all?

We didn't, although that that is something I've been thinking about doing, and it is also something I mean, I don't think we'll ever do a daily spever, but you could with the actually can see you know how many how many beat the market today? Anyway to the question, yes, so there aren't different categories. We've been talking a lot about the large cap category. The growth category is actually

quite interesting. So growth was one of those areas where the record of active managers had been going pretty strong. If we were here one year ago, you've been asking me why is it that I think it was a thirty percent of growth managers were out performing over three years UM. That record has strongly reverted to the mean with the downturn in growth. There's you mentioned Cathy Woods Arc Fund, which which came in for a lot of

perhaps unfair criticism. She was not alone. If you look over the three year period now at large cap growth, it's it's come back completely other the other way, it's under performing. And what you see is is that, yes, there is this aspect to which investors more generally I think, have come to their active managers and demanded They said, look, I can get very low cost access to my benchmark. What I need you to do is to focus on your best ideas and to concentrate on your highest conviction picks.

And I think many men managers have done that. It does make it then the end result a little more more of a broad distribution. Right there are either gonna win big or they're gonna lose big um. And it does in some categories like like growth, I mean that you can get quite strong extremes. I think there's evidence in our data suggest that the growth segment was kind of more growth than than our growth index in particularly

in the downturn in growth relatively that started back in September. Yeah, I think the I think I'm getting at here is if you were running a fund in the eighties and nineties, before indexing was big, you were used in the course, you were ben smart hugging largely because you couldn't get too crazy you can go you couldn't go for Cathy

would because you're sort of delivering core exposure. And I think that locks them in because there are a lot of their existing clients are those people who alathem for that. So I find that they're kind of in this sort of unfortunate like conundrum about still serving core exposure, so they can't go really active. But people weren't really active now because they use indexing for their core. Yeah, I

think I think you might be right. I would say I'm not an expert in anten eighties fund history, but there were concentrated technology funds at the time. There were you know, top twenty funds, just twenty great idea funds at the time. Um, I think you're right that more broadly, it used to be the case that managers could could essentially sell beta as alpha, that that might be a bit a bit unfair, but I think that's a lot

harder to do nowadays. I still think there's look, there's there's still massive need for active managers in our markets, and they do provide a valuable service in terms of you know, price efficiency an allocation of capital. The challenge I think is is your much do you need and how much do you as as an individual investor need to to allocate to a to an active manager when actually a lot of what's driving and performance to be yours allocation. So walk us through some other headlines here

we had an equities there, fixed income. Yeah, so, um so, I'll pick to too. Highlights from from other categories. The first is um so, international managers had a slightly better record in the latest Speeded edition and although again it's it's we're still not seeing categories generally where you get a high proportion of active managers beating the index over the long term. One area that we have commented upon frequently as one where the active record is much better

international small caps. So compared to an international small cap benchmarks, managers picking small international stocks have actually had a pretty good record over the long term. Fixed income well fixed income has been was it was a bit more of

a mix this year. One area where active funds seem to be having a particularly tough time was in the intermediate US US government, and I guess that's it's just a downturn in US government and also one of the typical strategies that managers use in fixed income going along the duration was a painful one this year. One area where we saw managers do actually pretty well was just general investment grade funds UM, seeing an under performance rate

of seventeen percent there um. So there does appear to be, at least in the short term, evidence for for strong performance from active managers in the fixed income space. So the fixed income has always been a little better than equity in these Beaver reports, and some say, well, look, if your benchmark is the AGG it doesn't hold high yield international. A lot of these managers will buy high

yield international, jag up the credit risk. Um do you account for that, because in the equity world, if you do that, you sort of get put into a different bucket that's called style drift. How do you account for that? Because I do think sometimes fixed income. The bond managers. Actually, I think I have it lucky. They've got this agg benchmark which is waited by debt. It's whereas the smps got like momentum baked into it. It's a harder index to beat on the bond side. I just feel like

maybe the index is easier to beat in general. Yeah, I mean, my my team took over the production of these reports quite recently and I did a deep dive into the fixed income segment. And let me, let me tell you something. Fixed income benchmarking is hard. It's really hard. Um. Telling how a fund in particular is generating its returns is difficult. Because I can take an equity fund, I

could tell you you've show me its performance. I can tell you whether it's investing in emerging markets or not simply by you know how it's doing and how emerging markets are doing. Whereas in fixed income, if you're taking a little bit of extra credit risk, if you're taking on a little bit more duration, if you're using tips, what you'll see is in the short term you'll return to be really really correlated is your benchmark. Over the long term, there will be a drift. And this makes

benchmarking really really difficult. I think there is a good point to be made there in terms of aggregate bond indices not representing what is the typical active manager activity. I do think there's an open question there, and I would certainly say that it's it's it's still a challenge. However, I still think the way we do speaver is the right way to do it, in the sense that we should be comparing what an active manager can do versus what is the simple choice in terms of gating broad

market exposure. Yeah, there's an index called the Bloomberg Universal Index, which is like the AGG, but it has a little high yield international. When we put that against intermediate total return managers, the beat rate guts cut in half. They become more like active stock pickers UM. But that that ticker for that universal is actually ETF growing pretty quickly. So some of these it's I U s B. It's one of the fastest growing and I could see why.

It's the AGG with a little extra something, and it's sort of, in my opinion, probably the best replacement for a bond manager versus say the AGG or be you know a g G R B N d UM. What one question I have is sometimes the speed reports come out, someone will be like, especially on Twitter, Hey, this is an index company. You know, of course they're going to

want to promote this. And you know what would you say to somebody say, this is actually in your vested interest to have all this these numbers be so bad? I get it, it's true. But do you ever get people saying that or do you get maybe active manager hate mail? Um? So well, let me let me say, first of all, if you are an outperforming active manager. Um, if you're one of theft in the short term or one of the ten percent in the long term in U S equities, you should love the Spever report because

what it shows is how special you are. So I don't get hate mail from from good active managers. Secondly, Um, what we committed to do was to report this number on a regular frequency, i e. Every six months, will report it when the numbers in our favor, will report it when the number isn't in our favor, and we'll try and give people perspectives UH and insights into what's driving those numbers. Now, you're right, the long term data does carry an implication that perhaps in an index based

approach could be suitable. Um. But the important point is that we commit to reporting those numbers whatever they are, and then let the data speak for itself. I noticed you guys asset weight a section of the report and then you equal weight is were there differences in the our performance when you do those two different methods, Yes, there are. So the reason we do both. So speeder is not a kind of weighted number. How many funds were there in the universe, how many beating the market? Um?

And obviously well not maybe not obviously, but but in practice, what what happens is that doesn't represent the invested assets. So there's a lot more money in some big funds than there are in many small funds. Um. So in the report we do report the equal weighted average returned from each category and the asset weighted returned from each category. If the big funds are doing better than the asset weighted performance should be better than the equal weight to performance.

Generally speaking, just sort of summarizing lots and lots of data pointance and lots of years of reports, asset wasted performance is better. Generally speaking, is that because money flow helps, because you're buying the stocks that the flows are coming in and therefore the stocks to go up when you buy them, which is sort of like a nice upward spiral. NOA. Is it more just the big managers are able to get better execution costs, they can actually move the market

in their favor. I think. I think that's part of it. I think also there are generally economies of scale or low. When we talked about fees, generally low fees do matter. Lower few funds do tend to attract more assets. And I think also bear in mind we're talking about the whole universe, so that the there's quite a long tale

here of potentially quite small funds with potentially quite high fees. Jim, what was the single most surprising thing that jumped out of you when you got your hands on this Dad report? Uh So, I think the the the one that I was most interested by was there was the reversion to

the meaning in growth managers. And the reason it was surprising is more often what you see is is the best thing for say the small cap US equity category is for large caps to do really well, because your small cap funds might have a few large caps and that sort of so compared to their benchmark, which is only small caps. See what I mean. The same happens for growth and value. So what happened this year is

that growth did really badly. And my expectation was was that that would be good for growth managers because they can have a little you know, a little bit of value as well if they want to UM and so j really and growth doing really badly made me think that growth managers would do relatively well. That did not happen.

And as as we said earlier, it's suggestive of the fact that growth managers actually we're really doubling down on the growthiest part of the market, as Eric was suggesting, you know, maybe concentrating with bets and so that that is something that seems to be corroborated by this day, so which I found really interesting and surprising. We talk growth. Value finally had its day, right, This is one of the big stories of the last year. How did value

managers do versus their benchmark value managers? UM It was not quite a coin flip, but pretty close of value managers A performed. Feels like they've been waiting for this moment, just like it's like the moment came and it's like, oh, well, I will say value e t fs have taken in a ton of money, like there's a real you can

tell people are like ready for a regime change. And I'm guessing their numbers were better than growth because they probably were diligently buying actual value stocks that were below value, whereas growth might have been, you know, sort of like leaning into more growthy stocks and got caught on the wrong side for the half of year. Maybe they'll flip back, but that makes sense to me in a way. Okay, damn question that we ask everyone at the end of

trillion's favorite et F ticker, what's yours? Well, as a representative of an index company, also have to kindly I'll answer that if you work at SMP, it has to be spy. I mean, I mean, it would be weird if it wasn't. He could have no comment, but okay, that's We'll just say a pretty strong contender. We'll say it's spy. Tim Edwards, thanks for joining us in Trillions.

You thanks for listening to Trillions until next time. You can find us on the Bloomberg terminal, Bloomberg dot com, Apple podcast, Spotify, or wherever else you'd like to listen. We'd love to hear from you more on Twitter. I'm at Joel Webber Show. He's at Air Caltunist. This episode of Trayance was produced by Magnus Hendricksen. Bye. M hm m m hm hmm