The Aversion to Market Returns

Americans have almost no affinity for the concept of average, or in the case of the stock market, market returns. From the time we’re very young most of us are told how exceptional we are. Throughout most our education, we’re told how exceptional the United States is. We are a nation of citizens who, for the most part, believe we are exceptional pieces of a most beautifully exceptional puzzle.

This aversion to average is the only way I can explain our continued love affair with active (as opposed to passive) money management. If this debate were based on peer-reviewed, empirically sound evidence, it would most certainly be over by now. While many individual investors have examined the evidence and shifted to a passive (or even better, evidence-based) investment methodology, a large majority continue to swing for the fences in the hope that they will defy all odds and pick the winning horse.

As Larry Swedroe recently pointed out, the incredible shrinking alpha continues: “. . . 20 years ago roughly 20% of active managers were generating statistically significant alpha, today that figure is down to about 2%.” For those who may not be exactly clear on what alpha signifies: in this case it is a fund manager’s ability to construct a fund that will outperform its risk-adjusted benchmark, net of fees.

The latest research from Standard & Poor’s confirms Mr. Swedroe’s findings. They recently released the results of the midyear S&P Indices Versus Active (SPIVA) scorecard. As the title of the study suggests, S&P looks at each fund category and quantifies how many funds manage to outperform their benchmark. The results, across each asset class, were nothing short of incredible.

To summarize:

  • Over the past year, 84.6% of large-cap managers, 87.9% of mid-cap managers and 88.8% of small-cap managers underperformed the S&P 500, the S&P MidCap 400 and the S&P SmallCap 600, respectively.
  • Over the five-year period, 91.9% of large-cap managers, 87.9% of mid-cap managers and 97.6% of small-cap managers lagged their respective benchmarks.
  • Over the 10-year period, 85.4% of large-cap managers, 91.3% of mid-cap managers and 90.8% of small-cap managers were unable to outperform their respective benchmarks.
  • Even in the category where active managers fared the best – large-cap value – just 32% outperformed the S&P 500 Value Index. In every other category, at least 80.9% of active managers underperformed their respective benchmarks.
  • SPIVA also found the exact same trend with international equity and fixed income.

While many often characterize achieving market returns as average, we would argue that, given the evidence, they are anything but. We could only be so lucky In fact, if our client’s portfolios take what the market gives them (which is the goal of our evidence-based philosophy) they would be “beating” a vast majority of investors.

If you have any questions about your investment strategy, contact Claris.

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