Active vs. Index-based Investing: An Update on Performance

The Mather Group, LLC (TMG) remains consistent in its belief that an index-based investment strategy is expected to outperform its more active competition over a long-term investment horizon. However, we continue to monitor the debate as new research emerges. S&P Global (S&P) provides a key tool in monitoring the performance of active versus index-based funds in its S&P Indices Versus Active (SPIVA) Scorecard.

active vs. INDEX-BASED INVESTING: an update on performance 

 

The Mather Group, LLC (TMG) remains consistent in its belief that an index-based investment strategy is expected to outperform its more active competition over a long-term investment horizon. However, we continue to monitor the debate as new research emerges. S&P Global (S&P) provides a key tool in monitoring the performance of active versus index-based funds in its S&P Indices Versus Active (SPIVA) Scorecard. S&P’s reporting accounts for:

  • Style Consistency: SPIVA measures style consistency as a fund having the same style classification (e.g., large-cap growth, large-cap value) at the beginning and end of a measurement period. Style drift can occur naturally as a fund’s winning investments change classification (e.g., a small-cap company grows to the point of being classified as mid-cap) or can be a result of a fund manager deciding to invest outside the mandate. Regardless of how style drift occurs, correct fund categorization is critical to ensuring that a fund’s performance is being evaluated against a fair benchmark. SPIVA accounts for this in its analysis and compares each fund to an appropriate index based on the fund’s actual portfolio.
  • Risk-Adjusted Returns: A fund that underperforms its index may still be a solid investment if it is taking less risk than its benchmark. SPIVA releases a separate report that accounts for differences in volatility across funds.
  • Survivorship Bias: S&P’s data set incorporates funds that have ceased operations.

The 2021 year-end SPIVA Scorecard reflected significant underperformance from actively managed funds for the year. In fact, 79.6% of active U.S. equity funds underperformed the S&P Composite 1500 index last year, making it the third-worst year for active funds since S&P began tracking this data in 2001.1

A common perception is that, while actively managed funds may underperform on an absolute level, they can better manage risk within the portfolio. After all, active funds have greater flexibility within the portfolio to take actions such as holding higher allocations to cash, rotating out of unattractive sectors, and overweighting top-performing investments. On the other hand, the index effectively stays the course and does not adjust to market trends.

However, S&P’s data found that active fund performance looks even worse on a risk-adjusted basis. While 90% of U.S. equity active funds underperformed their benchmark in absolute terms over the last 20 years, 95% underperformed when adjusting for risk.

Morningstar publishes similar research in its Active/Passive Barometer. A key difference in S&P and Morningstar’s research is in how they set their benchmarks. S&P uses the benchmark index as its comparison; however, it is not possible to buy an index directly. As a result, Morningstar compares the performance of active funds to passive index funds. The goal is to make a direct comparison between the investment outcome of allocating real money to active versus passive investment strategies.

Ultimately, Morningstar reaches a similar conclusion—over long-term time horizons, investors should expect that the average active fund will underperform its benchmark. In the past 10 years, only 26% of active funds succeeded in outperforming passive funds.2

Furthermore, Morningstar found that, for investors who intend to use active strategies in their portfolios, there is an advantage to choosing lower-cost active funds. For example, the average U.S. large-cap blend fund had a 9.5% chance of outperforming its benchmark for the past 10 years. For the lowest-cost funds in the sample, the chance of outperformance doubled to 19.2%, while the highest-cost funds had only a 1.3% chance of outperforming the benchmark. Additionally, more expensive funds were more likely to shut down completely during this time frame, with only 54% of the most expensive funds surviving the 10-year period, while 68% of the cheapest funds did so.2

There are a few key takeaways from S&P’s and Morningstar’s findings:

  • Index-based investment strategies historically outperform active strategies.
  • Longer time horizons tilt the odds further in favor of index-based investing strategies.
  • Investment costs matter.

The evidence continues to point toward a low-cost, index-based investment strategy, in alignment with TMG’s current approach. We will continue to monitor new research as it becomes available to help ensure we are aligned with what the data shows and to remain abreast of current innovations in the market, while placing an emphasis on maintaining low investment costs across our client portfolios.


SPIVA US Year-End 2021 Scorecard, Standard & Poor’s, March 2022.
Morningstar’s Active/Passive Barometer, Morningstar, February 2022.

The Mather Group, LLC (TMG) is registered under the Investment Advisers Act of 1940 as a Registered Investment Adviser with the Securities and Exchange Commission (SEC). Registration as an investment adviser does not imply a certain level of skill or training. For a detailed discussion of TMG and its investment advisory services and fees, see the firm’s Form ADV on file with the SEC at www.adviserinfo.sec.gov or on the firm’s website at www.themathergroup.com. The opinions expressed, and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. The opinions and advice expressed in this communication are based on TMG’s research and professional experience and are expressed as of the publishing date of this communication. All return figures and charts shown are for illustrative purposes only. TMG makes no warranty or representation, express or implied, nor does TMG accept any liability, with respect to the information and data set forth herein. TMG specifically disclaims any duty to update any of the information and data contained in this communication. The information and data in this communication does not constitute legal, tax, accounting, investment, or other professional advice. Investing involves some level of risk. Past performance does not guarantee future results. An investor cannot invest directly in a presented index, as an investment vehicle replicating an index would be required. An index does not charge management fees or brokerage expenses. Please feel free to contact us for additional information on any indices mentioned.


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