As we head into the final innings of 2020, it will go down as a year of extreme peaks and valleys for financial markets. During the spring, broad equity ETFs such as the Schwab U.S. Broad Market ETF (SCHB) and SPDR S&P 500 Trust (SPY) sunk more than 25% in value. Since then, they’ve staged a sharp recovery and both funds now have year-to-date gains of 7.3% to 7%, respectively.
Despite the dramatic change in market sentiment, the difficulty in outperforming the indexes has been the one constant of 2020. According to the mid-2020 SPIVA U.S. Scorecard from S&P Dow Jones Indices, which was released this autumn, actively managed funds have struggled to keep pace with their index counterparts.
“In 11 out of the 18 categories of domestic equity funds, the majority of funds continued to underperform their benchmarks,“ the report said. The majority of large-cap (63%) and multi-cap (65%) funds underperformed their peer index for the one-year period ending June 30, 2020.
The outperformance by indexes also held true with growth and value stock funds. For example, large cap (82% of growth funds, 86% of value funds), mid cap (growth 60%, value 81%) and small cap (growth 57%, value 90%) underperformed their peer index benchmark over the past decade. S&P’s growth, value and blended U.S. equity indexes are tracked by iShares and SPDR ETFs.
The underperformance by portfolio managers in the mid- and small-cap category is noteworthy. Managers argue that inefficient markets with smaller stocks can lead to better opportunities for stock pickers compared to more heavily researched areas like large-cap stocks. While the argument seems plausible, the aggregated results by mid- and small-cap stock pickers has still disappointed.
The results for fixed-income funds illustrates similar trends.
The majority of active bond funds in 13 out of 14 fixed-income categories failed to beat their index counterpart. Government bond funds with long (92%), intermediate (63%) and short-term (68%) maturities underperformed during the past year. And the longer-term performance for these same funds was even worse, with long (98%), intermediate (81%) and short-term (75%) bond funds underperforming their rival index.
How should financial advisors interpret the data?
First, building portfolios with a core strategy around index-linked ETFs has proven to be a solid strategy that will outperform most active managers during just about any market climate.
Second, there will always be a small minority of active funds that beat their rival index. However, pre-identifying these outperformers is difficult. Moreover, even after outperformers have been identified, there’s no certainty their record of outperformance can be sustained over long time horizons.
Finally, using active management as a complementary strategy to a core portfolio of index ETFs offers a happy balance of active management with indexing. It also prevents a client’s entire portfolio from suffering if active managers are unable to outperform their yardsticks.
Altogether, the SPIVA U.S. Scorecard report examined the historical performance for 18 U.S. equity, 14 fixed income and 4 international equity S&P benchmark indexes.
Ron DeLegge is founder and chief portfolio strategist at ETFguide, and is the author of “Habits Of The Investing Greats.”